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MAY  31 


INTRODUCTION    TO    ECONOMICS 


BY 


ALVIN    S.    JOHNSON,  Ph.D. 

PROFESSOR   OF   ECONOMICS    IN   THE   UNIVERSITY    OF   TEXAS 


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4  5  S  ^  f) 

D.    C.   HEATH    &    CO.,    PUBLISHERS 
BOSTON        NEW   YORK        CHICAGO 


Copyright,  1909, 
By  D.  C.  Heath  &  Co. 


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S  PREFACE 

"~"  A  CURSORY  examination  of  the  contents  of  this  book  will 
probably  give  the  impression  that  the  theoretical  aspects  of  the 
science  receive  in  it  greater  emphasis  than  present  opinion 
among  economics  teachers  can  approve.  The  writer  may  be 
permitted  to  urge,  in  his  own  defense,  that  the  method  which  he 

■^    has  employed  was  chosen  not  without  careful  consideration  of 

^  the  existing  situation  in  the  field  of  economics  instruction.     In 

\  the  present  stage  of  university  evolution,  economics  is  almost 
everywhere  taught  by  men  who  have  been  trained  in  the  science; 
a  text-book  writer  is  therefore  justified  in  relying  upon  the 
teacher  for  the  supplying  of  many  of  the  concrete  facts  which  in 
a  given  situation  are  most  effective  for  purposes  of  instruction. 

'^i    An  efficient  teacher  can  base  a  highly  practical  course  upon  a 

^*  text- book  which  is  fundamentally  theoretical. 

Moreover,  in  most  colleges  and  universities  the  general  course 

in  economics  is  usually  followed  by  special  courses,  and  these, 

in  order  to  attract  any  considerable  number  of  students,  must 

\  be  practical.     It  is  not  too  much  to  say  that,  for  a  majority  of 

<5S  students,  theoretical  study  begins  and  ends  with  the  introductory 
i  course.     Such  a  course  ought,  therefore,  to  present  a  reasonably 

V    thorough  study  of  the  general  principles  of  the  science. 

The  arrangement  of  material  in  this  book  will  perhaps  require 
a  few  words  of  explanation.  Every  one  recognizes  that  the  fun- 
damental problem  of  economics  is  the  problem  of  value.  It  is 
only  when  treated  from  the  view-point  of  value  that  much  of  the 
material  usually  included  in  works  of  economics  under  the  head 
"  Production,"  deserves  a  place  in  the  science.  The  student 
cannot  too  early  familiarize  himself  with  the  true  point  of  view 
of  economics  ;  I  have,  therefore,  placed  the  exposition  of  value 
in  the  forefront  of  my  work.  "  Production  "  I  have  treated  not 
independently,  but  chiefly  in  its  relation  to  cost,  and  consequently 

iii 


iv  PREFACE 

have  placed  Chapters  VI-IX  immediately  after  the  chapter  on 
Cost  of  Production.  No  pretense  is  made  of  treating  produc- 
tion exhaustively :  the  writer  is  persuaded  that  this  can  be  done 
much  more  satisfactorily  through  courses  in  economic  history, 
economic  geography,  or  industrial  economics,  than  through  an 
introductory  work  in  general  economics. 

In  a  philosophical  exposition  of  the  principles  of  economics, 
it  would  perhaps  not  be  permissible  to  insert  a  study  of  labor 
organization  between  the  theory  of  wages  and  the  theory  of 
interest,  as  has  been  done  in  this  work.  In  a  practical  intro- 
duction to  economics,  on  the  other  hand,  this  seems  to  the  writer 
not  only  permissible,  but  advisable.  No  useful  end  is  attained 
by  relegating  labor  organization  to  a  limbo  of  "  applied  eco- 
nomics "  months  distant  from  the  general  discussion  of  wages. 
When  this  method  is  adopted,  the  student  is  almost  certain  to 
feel  that  the  theoretical  discussion  leaves  no  place  for  the  most 
prominent  factor  in  the  field  of  labor  ;  and  "so  much  the  worse 
for  theory."  I  have  placed  Chapters  X  and  XI  in  juxtaposition, 
in  order  that,  with  the  teacher's  aid,  the  student  may  adjust  the 
theory  to  the  facts,  and  interpret  the  facts  in  the  light  of  the 
theory. 

The  greatest  difhculty  that  the  writer  has  encountered  lies  in 
the  problem  of  capital  and  interest.  An  elementary  text-book 
offers  no  proper  place  for  the  treatment  of  opposing  theories. 
The  writer  would  have  found  nothing  more  to  his  liking  than  to 
balance  the  arguments  of  the  agio  and  the  productivity  schools, 
reconciling  them  so  far  as  this  is  possible;  in  his  experience  as 
a  teacher,  however,  he  has  found  that  such  a  plan  is  inevitably 
destructive  of  the  student's  interest  in  economic  science.  The 
productivity  theory  is  employed  merely  as  more  teachable  than 
the  agio  theory,  and  as  presenting  a  better  approach  to  practical 
problems,  such  as  stock-watering,  public  determination  of  rates 
and  charges,  etc.  An  attempt  has  been  made,  however,  to  famil- 
iarize the  student  with  the  method  of  thought  of  the  opposing 
school  in  the  treatment  of  the  phenomenon  of  capitalization. 
Land  is  treated  as  a  form  of  capital,  chiefly  because  it  appears 
to  the  writer  that  this  method  of  treating  the  subject  is  destined 


PREFACE  V 

to  gain  wide  acceptance,  although  it  is  his  personal  conviction 
that  economics  has  gained  little  and  lost  much  through  the 
abandonment  of  the  old-fashioned  distinction  between  land  and 
capital. 

It  is  perhaps  superfluous  for  the  writer  to  mention  the  names 
of  the  economists  to  whom  he  is  especially  indebted.  The  the- 
cr}^  of  value  presented  is  in  large  part  derived  from  the  works 
of  von  Wieser,  Bohm-Bawerk,  and  Clark;  the  theories  of  wages 
and  interest  follow  closely  those  of  Professor  Clark  ;  the  treat- 
ment of  rent  and  capitalization  is  influenced  by  the  writings  of 
Professors  Fetter,  Fisher,  and  Seligman.  In  his  discussion  of 
profit,  the  author  is  chiefly  indebted  to  Clark,  Landry,  and 
Hawley ;  in  his  discussion  of  monopoly  value,  he  has  made  free 
use  of  the  writings  of  Professors  Marshall,  Ely,  and  Clark.  In 
the  chapter  on  diminishing  returns,  the  reader  will  recognize 
the  influence  of  Professors  Marshall  and  Carver.  Among  other 
modern  economists  from  whom  he  has  borrowed  are  Adams  and 
Sumner,  Jenks  and  Meade. 

UNivERsrrv  of  Chicago, 
May  iS,  191 1. 


CONTENTS 


PAGE 

Chapter  I.    The  Nature  of  Economic  Science         .        .        i 

I.  Significance  of  the  desire  for  wealth,  i.  —  2.  The  desire  for  wealth  not  alto- 
gether a  selfish  motive,  3. —  3.  Definition  of  wealth,  4.-4  Human  services  as 
wealth,  4.  —  5.  Objects  of  desire  that  are  not  wealth,  5.  —  6.  Present  and  future 
wants  in  their  relation  to  wealth,  6.  —  7.  Value  the  common  characteristic  of  all 
forms  of  wealth,  6.  —  8.  Definition  of  economics,  7.  —  9.  Economic  significance 
of  the  laws  governing   human  wants,  8.  —  10.    The  production  of  wealth,  8.  — 

II.  The  distribution  of  wealth,  9—  12.    The  practical  objects  of  economic  science, 

0.  —  13.  The  relations  of  economics  and  politics,  10.  —  14.  Economics  as  a  de- 
veloping science,  12.  —  15.    The  exchange  economy,  12.  —  16     Competition,  14. 

—  17.   Restrictions  upon  competition,  16.  —  18.    Economic  classes,  16.  —  19.   Sig-     ^  " 
nificance  of  the  laws  of  price,  18.  —  20.    Summary,  19. 

Chapter  II.    Utility,  Value,  and  Price      ....      21 

1.  Significance  of  the  development  of  wants,  21.  — 2.    Elasticity  of  wants,  22. 

—  3.  Law  of  diminishing  intensity  of  wants,  23.  —  4.  Utility,  23.  —  5.  Law  of 
diminishing  utility,  25.-6.  Marginal  utility,  26.  —  7.  Effective  utility,  27.— 
8.  Economic  function  of  comparison  of  utilities,  28.  —  9.  Personal  value,  29. — 
10.  Socialization  of  personal  values  through  imitation,  30.  — 11.  Socialization 
of  personal  values  through  e.xchange,  32.  —  12.  Personal  exchange  value,  34  — 
13.  Price,  35.  —  14.  The  determination  of  price  in  a  market,  36.  -  15.  Demand 
and  supply,  39.  —  16.  Qualification  of  the  principle  that  marginal  buyers  and 
sellers  control  prices,  40.  —  17.    Summary, 

Chapter  III.    Normal  Competitive  Price    ....      43 

I.   Fluctuations  in  market  prices,  43.  —  2.  Fluctuations  in  the  prices  of  perishable  ■, 

commodities  contrasted  with  fluctuations  in  prices  of  imperishable  ones,  44.  — 
3.  Effect  of  extension  of  the  market  upon  price  fluctuations,  44.  —  4.  The  normal 
price  level,  45.  —  5.  Influences  determining  the  normal  price  level,  47.  —  6.  Re- 
lation of  cost  of  production  to  normal  price,  48.  —  7.  Conflict  of  interest  of  the 
individual  producers,  50.  —  8.  Conditions  upon  w*hich  adjustment  of  prices  to  the 
normal  level  depends,  52.  —  9.  Deviations  from  the  normal  price  level  in  agri- 
cultural productions,  52.  —  10.  Relation  of  large  antecedent  costs  to  price  devi- 
ations, 53.  —  11.  Joint  products,  54.  —  12.  Forces  determining  the  short-period 
normal  price  level,  55.  —  13.  The  long-period  normal  price  level,  58.  —  14.  Sum- 
mary, 59. 

Chapter  IV.     Monopoly  Price 60 

I.  Price  control  dependent  upon  control  of  supply,  60.  —  2.  Definition  of  mo- 
nopoly, 61.  —  3.  Monopolies  established  through  combinations  of  producers,  61. 
—  4.  Monopolies  established  through  control  of  an  essential  element  in  produc- 
tion, 62.  —  5.  Intimidation  as  a  means  of  monopoly  control,  64.  —  6.  Influence 
of  competition  upon  partial  monopolies,  65.  — 7.  Law  of  monopoly  price,  66.  — 
8.  Influence  of  elasticity  of  demand  upon  monopoly  price,  68.  —  9.  Permanent 
and  temporary  monopolies  compared,  69.  —  10.  Classification  of  consumers  for 
purposes  of  monopoly  exploitation,  71.  —  11.   Monopolistic  price  discriminations 

vii 


viii  CONTENTS 


PAGB 

in  favor  of  foreign  consumers,  73.  —  12.   Charging  what  the  traffic  will  bear,  74. 

—  13.    Limits  upon  monopolistic  exploitation,  75.  —  14.    Summarj',  76. 

Chapter  V.    The  Cost  of  Production         .        .        .        .      T] 

I.  Prices  dependent  upon  cost  of  production,  77.  —  2.  Laws  governing  the  prices 
of  the  materials  of  production,  78.  —  3.  Fluctuations  in  the  price  of  finished  prod- 
ucts are  reflected  in  fluctuations  in  the  prices  of  producers'  goods,  79.  — 4.  The 
benefits  of  a  rise  in  price  of  a  finished  product  may  rest  permanently  with  the  pro- 
ducers of  the  crudest  material  entering  into  that  product,  80.  —  5.  The  rent  of 
land  suitable  for  one  use  only  fluctuates  with  the  price  of  its  product,  81.  —  6.  The 
wages  of  labor  are  sometimes  directly  dependent  upon  the  price  of  the  product  of 
labor,  82.  —  7.    Relation  to  wages  of  the  cost  of  other  elements  in  production,  84. 

—  8.  Alternative  uses  of  producer's  goods  as  affecting  their  relation  to  the  price  of 
a  particular  product,  86.  —  9.  Competition  of  producing  districts,  87.  —  10.  Price- 
determining  and  price-determined  costs,  89.  —  11.    Summary,  go. 

Chapter  VI.    The  Law  of  Diminishing  Returns         .        .      91 

I.  Increase  in  the  output  of  an  industry  is  limited  by  increase  in  cost  of  some 
factor  or  factors,  91.  — 2.  Increase  in  the  business  of  a  single  establishment  usu- 
ally limited  by  the  difficulty  of  increasing  one  or  more  factors,  92.  —  3.  In  most 
cases  the  output  of  an  establishment  can  be  increased  only  at  more  than  propor- 
tionate increase  in  cost,  94.  —  4.  Dimini? hing  returns  in  agriculture,  95.  — 
5.  Diminishing  returns  operate  more  severely  in  some  forms  of  agriculture  than 
in  others,  96.  —  6.  Diminishing  returns  in  urban  improvements,  97. —  7.  Dimin- 
ishing returns  in  transportation,  99.  —  8.  When  the  amount  of  labor  increases 
while  the  amount  of  capital  remains  fixed,  the  law  of  diminishing  returns  be- 
comes operative,  100.  —  9.  L^niversal  application  of  the  law  of  diminishing  re- 
turns, loi.  — 10.  The  test  of  economy  in  production,  101.  — 11.  Influences 
which  counteract  the  tendency  toward  diminishing  returns,  103.  —  12.  Sum- 
mary, 104. 

Chapter  VII.   The  Specialization  of  Economic  Functions.     io6 

I.  Economic  functions  undifferentiated  under  primitive  conditions,  106.  —  2.  Ex- 
change as  the  original  force  making  for  differentiation  of  economic  functions, 
107.  —  3.  Effect  of  production  for  a  general  market,  108.  —  4.  Dependence  of  eco- 
nomic differentiation  upon  the  form  of  commercial  organization,  109.  — 5.  Effect 
of  improvements  in  transportation  upon  economic  differentiation,  no.  —  6.  Effect 
of  increasing  density  of  population,  in.  — 7.  Relation  of  the  form  of  economic 
organization  to  economic  differentiation,  112.  —  8.  Business  advantages  arising 
from  the  division  of  labor,  113.  —  9.  .Social  advantages  arising  from  the  division 
of  labor,  115.  —  10.  Disadvantages  of  the  division  of  labor,  117.  —  n.  Division 
of  labor  as  a  force  counteracting  Siminishing  returns,  118.  —  12.    Summary,  120. 

Chapter  VIII.    The  Concentration  of  Industry         .        .    I2i 

I.  Increase  in  size  of  the  business  establishment,  121.  —  2.  Concentration  de- 
pendent upon  the  facilities  for  assembling  materials,  122.  —  3.  Concentration 
limited  by  the  extent  of  the  market,  123. —  4.  Effect  upon  concentration  of 
improvements  in  transportation,  123  —  5.  Effect  upon  concentration  of  the 
growth  of  large  fortunes,  124  — 6.  The  corporation,  125.  —  7.  The  large  estab- 
lishment can  make  the  fullest  use  of  division  of  labor,  126.  —  8.  It  can  avail  itself 
of  the  most  effective  machinery,  127.  —  9.  It  enjoys  cheaper  power,  128.  —  10.  It 
wastes  less  material,  129.  —  n.  It  can  develop  valuable  by-products  from  waste, 
129.  —  12.  It  buys  more  cheaply  and  sells  at  better  prices,  130.  —  13.  It  secures 
lower  rates  of  transportation,  131.  —  14.  It  pays  exceptionally  low  rates  of  inter- 
est, 132.  —  15.  The  advantages  of  concentration  vary  from  industry  to  industry, 
132.  —  16.  The  gains  from  concentration  are  subject  to  a  law  of  diminishing  re- 
turns, 134.  —  17.    Summary,  136. 


CONTENTS  ix 


PAGH 

Chapter  IX.     Business  Combinations 137 

I.  Present  tendency  toward  combination,  137.  —  2.  Combination  of  competing 
business  units,  138. —  3.  Industrial  integration,  138.  —4.  Temporary  combina- 
tions, 139. —  5.  Partial  combinations,  140. — 6.  Consolidation,  141.  —  7.  Pooling, 
141.  — 8.  The  trust,  143. — 9.  The  holding  company,  143. —  10.  Consolidation 
increases  productive  efficiency,  144.  —  11.    It  encourages  specialization,  145. — 

12.  It  reduces  costs  of  shipment,  145.  —  13.  It  makes  possible  a  better  adjust- 
ment of  supply  and  demand,  146.—  14.  It  reduces  costs  of  marketing,  147. — 
15.  It  reduces  interest  charges  on  borrowed  capital,  148.  —  16.  Within  limits, 
consolidation  makes  possible  the  control  of  prices,  149  —  17.    Summary,  149. 

Chapter  X.     Competitive  Wages 151 

I.  Definition  of  labor,  151.  —  2.  Definition  of  wages,  152.  — 3.  The  importance 
of  the  problem  of  contract  wages,  153.  —  4.  Wages  vary  according  to  the  con- 
ditions under  which  labor  is  employed,  154.  — 5.  Equal  wages  for  equal  tasks, 
154. — 6.  Wages  cannot  exceed  the  marginal  productivity  of  labor,  156.-- 
7.  Under  competition  wages  cannot  long  be  less  than  the  marginal  product  of 
labor,  157.—  8.  Effect  upon  wages  of  increase  in  the  efficiency  of  labor,  159.  — 
9.  Effect  upon  wages  of  increase  in  the  number  of  laborers,  159.  —  10.  Effect 
upon  wages  of  improvements  in  production,  160.  —  11.  A  reduction  in  the  rate 
of  interest  raises  wages,  161.  —  12.    Non-competing  classes  of    laborers,  162. — 

13.  Effect  upon  wages  of  the  apportionment  of  new  laborers,  163.  —  14.  Per- 
manent influences  affecting  the  distribution  of  labor,  164.  —  15.  The  standard  of 
living,  i6g.  —  16,    Summary,  172. 

Chapter  XI.    Wages  as  affected  by  Labor  Organization     173 

I.  Inferiority  of  the  laborer  in  bargaining  power,  173  — 2.  Labor  organization 
as  a  means  of  increasing  the  bargaining  power  of  labor,  173.  —  3.  The  trade 
union,  174.  —4.  The  closed  shop,  175.  —  5.  Apprenticeship  regulations,  176.  — 
6.  The  importance  of  trade-union  funds,  178.  —  7.  Alliances  between  trade 
unions,  178.  —  8.  National  labor  organizations,  179  — 9.  The  American  Feder- 
ation of  Labor,  181. —  10.  The  strike,  181.  —  11.  The  boycott,  182. — 12.  The  re- 
lation of  trade  unionism  to  the  strike  and  boycott,  183.  —  13.  Collective  bargaining, 
184.  —  14.  Voluntary  arbitration,  185.  —  15.  Public  opinion  and  arbitration,  186. 
— 16.  Compulsory  arbitration,  187.  —  17.  Labor  organization  and  the  competi- 
tive law  of  wages,  188.  -  18.  Restriction  of  output  as  a  cause  of  reduced  wages, 
189.  —  ig.    Summary,  190. 

Chapter  XII.    The  Productivity  of  Capital      .        .        .     192 

I.  Capital  goods,  192  — 2.  Capital  a  fund  of  productive  wealth,  193.  —  3.  The  per- 
manence of  capital,  194.  —  4.  Acquisitive  and  productive  capital,  196.  —  5.  Arti- 
ficial and  natural  capital,  197.  —  6.  Saving,  197.  —  7.  The  growth  of  natural 
capital,  199. — 8.  The  productivity  of  capital  goods,  199.  —  g.  The  productivity 
of  capital,  200.  — 10,  The  productivity  of  capital  determined  at  the  margin,  201. 
—  II.  Effects  of  an  increase  in  capital,  204.  —  12.  Law  of  diminishing  productiv- 
ity of  capital,  205.  —  13.  Influences  counteracting  the  law  of  diminishing  pro- 
ductivity of  capital,  207  —  14.  Effect  upon  the  productivity  of  natural  capital  of 
increase  in  artificial  capital,  207.  —  15.  Equalization  of  returns  to  capital  through 
revaluation,  208.  —  16.  Equalization  of  returns  to  capital  through  mobility  of 
capital,  209.  — 17.  Barrier  preventing  the  free  flow  of  capital  from  industry  to 
industry,  211.  —  18.    Summary,  213. 

Chapter  XIII.     Rent,  Interest,  and  Capitalization  .        .    215 

I.  Popular  meaning  of  the  term  rent,  215. — 2.  The  traditional  scientific  use  of  the 
term,  2x5.  — 3.  Rent  as  the  product  of  a  capital  good,  216.  — 4.  Rent  restricted 
to  the  product  of  durable  capital   goods,  21O. — 5.    Rent  and   interest,  217.— 


X.  CONTENTS 


PAGE 
6.   Rent  as  a  residue,  218.  —  7.   The  determination  of  the  rent  of  one  of  several 
goods  entering  into  a  permanent  combination,  221.  —  8.    The  rent  of  a  reproduc- 
ible capital  good  tends  to  equal  interest  on  the  cost  of  replacing  the  good,  221.  — 

9.  The  relation  of  ground  rent  to  wages  and  interest  on  artificial  capital,  222.  — 

10.  The  relation  of  the  prices  of  the  products  of  land  to  the  rent  of  the  land,  225. 
—  II.  The  tendency  of  ground  rents  to  rise,  227,  — 12.  Capitalization,  228. — 
13.  MethoJ  D*^  ascertaining  the  amount  of  capital  in  reproducible  and  irreproduc- 
ible  goods,  !!28.  — 14.  Effect  of  an  increase  of  artificial  capital  upon  the  volume 
of  land,  231,  —  15.    Summary,  231. 

Chapter  XIV.    Enterprise  and  Business  Profits       .        .    233 

I.  Business  opportunities,  233. — 2.  Enterprise,  234.  —  3.  The  relation  between 
economic  changes  and  the  opportunities  for  enterprise,  236.  —  4.  Enterprise  a  risk, 
236.  —  5.  Enterpiise  and  imperfect  competition,  237.  —  6.  Definition  of  profit, 
238.  —  7.  The  nature  of  profits,  238.  —  8.  Profits  due  to  abnormally  low  wages 
and  interest,  240. — g.  Profits  due  to  the  transfer  of  labor  and  capital  from  one 
environment  to  another,  241.  —  10.  Profits  due  to  the  transfer  of  an  industry*  from 
one  environment  to  another,  243.  —  11.  Conditions  under  which  all  enterprises 
gain  profits,  244.  —  12.  Profit  a  temporary  incon.»,  245. —  13.  Monopoly  profits 
may  have  permanence,  246.  —  14,  Monopoly  may  be  capitalized,  248.  —  15.  Func- 
tion of  competitive  profit,  249.  —  16.  The  evil  effect  of  monopoly  profits,  250.  — 
17.    Summary,  251. 


253 


Chapter  XV.     Money  ....... 

I.  Definition  of  money,  253.  —  2.  Origin  of  money,  254. — 3.  Functions  of 
money,  255.-4.  Qualities  that  money  should  have,  256.  —  5.  Lack  of  uni- 
formity in  money  without  government  control,  257.  —  6.  Functions  of  govern- 
ment relative  to  the'monetary  system,  258.  —  7.  Methods  of  maintaining  parity, 
260. — 8.  Gresham's  law,  261.  —  9.  The  value  of  money,  262.  —  lo.  Measure- 
ment of  fluctuations  in  the  value  of  money,  263.  —  11.  Effects  of  changes  in  the 
quantity  of  money,  263.  —  12.  Effect  on  prices  of  the  issue  of  paper  money,  266. 
^13.   Effect  on   prices  of  the   introduction   of  substitutes  for  money,  266. — 

14.  Effect  of  changes  in  the  volume  of  business  upon  the  value  of  money,  267.  — 

15.  The  effects  of  an  increase  in  the  supply  of  money  not  capable  of  exact 
measurement,  268.  — 16,  Importance  of  changes  in  the  price  level,  269. — 
17.  Government  regulation  of  the  money  supply,  271.  —  18.  The  silver  move- 
ment, 272.  —  19.  Probable  effects  of  free  silver,  273.  —  20.  International  bimet- 
allism, 273. —  21.  Decline  of  the  silver  party,  274.-22.  Paper  money,  274. 
—  23.    Forces  regulating  the  value  of  gold,  277.  —  24.    Summary,  277. 

Chapter  XVI.     Financial  Institutions:  The  Bank    .         .    280 

I.  Finance  as  the  placing  of  capital,  2S0.  —  2.  Forms  of  capital  placement,  281.— 
3.  The  loan,2Si.  — 4.  Disguised  loans,  282.  —  5.  Credit,  283.  —  6.  Credit  instru- 
ments, 283.-7.  Demand  for  a  supply  of  loanable  capital,  284. —8.  Functions 
of  the  bank,  286.  —  9.  Bank  loans  regarded  as  the  purchase  of  credit  instruments, 
289. —  10.  Kinds  of  investments  suitable  for  banking  purposes,  290.  —  11.  De- 
posits arising  out  of  loans,  291.  — 12.  The  clearing  system,  293.  —  13.  Bank 
reserves,  294.  —  14.  Risks  incurred  by  bank  depositors,  296.  —  15.  Pank  notes, 
297.  —  16.  Restrictions  upon  note  issue,  298.  —  17.  Notes  and  depos'ts  as  cur- 
rency, 300.  —  18.    Summary,  300. 

Chapter  XVII.    Other  Financial  Institutions  .         .     303 

I.  Permanent  investment  of  free  capital,  303.  —  2.  Demand  for  long-term  invest- 
ment funds,  303. —  3.  Supply  of  long-term  funds,  305.  — 4.  Instruments  of 
long-term  investments,  306—5.  Variation  in  security  of  investments,  307.— 
6.    Variation   in   transferability   of  investments,    30S.  —  The   productiveness  of 


CONTENTS 


PAGE 

an  investment,  308.  —  8.  Effect  of  risk  upon  productiveness,  309.  —  9.  Effect  of 
difficulty  of  transfer  upon  productiveness,  310.  —  10.  Machinery  for  placing  cap- 
ital, 310  —  II.  Stock  Exchange,  312,-12.  Speculation,  312.  —  13.  Economic 
function  of  speculation,  313.--  14.  Underwriting  syndicates,  315.  —  15.  The  in- 
vestment company,  316.  —  16.  The  savings  bank,  317. —  17.  The  building  and 
loan  association,  319.  —  18.  The  life  insurance  company,  320.  —  19.  Complexity 
of  the  financial  mechanism,  321.  —  20.    Summary,  322. 

Chapter  XMII.    International  Trade  and  Foreign  Ex- 

CHANGE  ....         .        .         .         .         .         .    324 

I.  The  basis  of  permanent  trade,  324.  —  2.  Local  and  interregional  trade,  326.  — 
3.  Interregional  trade  based  upon  absolute  differences  in  productive  powers, 
327.  —  4.  Interregional  trade  based  upon  relative  differences,  327.  —  5.  Interna- 
national  trade  may  originate  in    differences   in  character  of  population,  328. — 

6.  It  may  originate  in  differences  in   relative  supply  of  natural  agents,  329.  — 

7.  It  may  originate  in  differences  in  the  supply  of  capital,  330.  —  8.  It  may 
originate  in  cifferences  in  traditions  of  workmanship,  331.  —  9.  The  foreign 
trade  of  a  modern  nation  is  based  upon  a  variety  of  conditions,  332.  —  10.  Rela- 
tive, not   absolute   advantages   in  production    give    rise   to  exportation,  333.  — 

II.  Relative   advantages   are   reflected    in   money   cost   of    production,   334. — 

12.  Application    of    the    piinciples    of    distribution    to    foreign   trade,   335. — 

13.  Trade  between  countries  is  essentially  barter,  337.  —  14.  Bills  of  exchange, 
338.  —  15.  Fluctuations  in  the  price  of  bills  of  exchange,  339.  —  16.  Conditions 
determining  the  price  of  bills.  340.  —  17.  Exchange  on  all  foreign  points  tends  to 
fluctuate  uniformly,  342.—  18.  Effect  of  increase  in  exports  or  in  imports  upon 
the  price  of  foreign  bills,  344.  —  19.  EiYect  upon  exports  and  imports  of  fluctua- 
tions in  foreign  bills,  344.  —  20.  Exportation  and  importation  of  gold,  345. — 
21.    Summary,  347. 

Chapter  XIX.    The  Regulation  of  Foreign  Trade  .        .    348 

I.  Foreign  trade  regulated  by  taxation,  348.  —  2.  Revenue  and  protective  duties, 
349.  —  3.  Popularity  of  revenue  duties  on  imports,  350.  —  4.  Import  duties  borne 
by  the  consumer,  352.  —  5.  Protective  duties  as  a  means  of  maintaining  the 
money  supply,  352.-6.  Fallacy  of  discouraging  importation  from  countries 
which  do  not  take  commodities  in  exchange,  353.  —  7.  Fallacy  of  patronizing 
home  industry,  354.  —  8.  General  protection  an  impossibility,  356.  —  9.  Wages 
not  dependent  upon  protection,  357.  —  10.  Protection  may  reduce  real  wages,  359. 
• —  II.  Some  of  the  effects  of  protection  are  seen,  while  others  are  unseen.  361.  — 
12.  Protection  may  increase  the  product  of  industry  if  the  government  has  better 
business  ability  than  the  body  of  private  enterprisers,  362.  —  13.  Protection  may 
aid  productive  industries  in  overcoming  the  hardships  of  infancy,  363.  —  14.  Pro- 
tection should  be  withdrawn  from  an  establ  shed  industry,  364.  — 15.  Difficulty 
of  determining  when  protection  becomes  unnecessary,  365.  —  16.  Inadvisability 
of  establishing  industries  requiring  permanent  protection,  365.  —  17.  Protection 
as  a  means  of  preserving  natural  resources,  367.  —  18.  Protection  as  a  means  of 
preserving  the  vigor  of  the  working  population,  368.  —  19.  Protection  as  a  means 
of  making  a  country  independent  in  time  of  war,  369.  —  20.  Inadvisability  of 
seeking  complete  self-sufficiency,  370.  —  21.  Retaliatory  duties,  371.  —  22.  Sum- 
mary, 373. 

V 

Chapter   XX.      The   Relations  of   Government  to   the 

Economic  Organization       ....         .         .    374 

1.  Interdependence  of  law  and  economics,  374.  —  2.  Free  enterprise,  375.  — 
3.  Criticism  of  the  system  of  free  enterprise,  376.  —  4.  The  question  of  produc- 
tive efficiency,  377. —  5.  The  question  of  distribution,  377.  —  6.  Distribution  as 
between  recipients  of  profits,  378.  —  7.    As  between  laborers,  379.  —  8.    No  stand- 


Xii  CONTENTS 


ard  of  justice  ascertainable  in  distribution  between  different  classes,  379.  —  9  In- 
equalities in  bargaining  powers  vitiate  the  results  of  free  contract,  380.  —  10.  Free 
enterprise  approaches  justice  only  when  competition  rules,  380.  —  11.  Need  for 
governmental  interference,  381.  —  12.  Regulation  of  qualities  of  goods  and  ser- 
vices, 383.  —  13.  Regulation  of  the  prices  of  goods  or  services,  384.  —  14.  Regu- 
lation of  the  conditions  of  employment,  386.  —  15.  Regulation  of  wages,  388.  — 
16.  Regulation  of  relations  of  landlord  and  tenant,  creditor  and  borrower,  direc- 
tor and  stockholder,  38;.  —  17.  Governmental  regulation  not  incompatible  with 
free  enterprise,  391.  —  18.  Government  ownership  for  revenue,  392.  —  19.  Gov- 
ernment ownership  for  purposes  of  regulation,  393  — 20.  Industries  producing 
inappropnable  utilities,  395.  —  21.  Conditions  under  which  public  replaces  pri- 
vate enterprise,  398.  —  22.    Summary,  399. 


INTRODUCTION    TO    ECONOMICS 

CHAPTER    I 

THE   NATURE   OF   ECONOMIC    SCIENCE 

1.  TJie  desire  for  zvcalth  has  in  all  ages  beeti  one  of  the 
principal  viotives  of  hntnan  action. 

From  the  earliest  time  of  which  we  have  record  a  great 
part  of  the  activity  of  man  has  been  occupied  with  the 
production  or  acquisition  of  wealth  —  material  objects  and 
personal  services  upon  the  control  of  which  human  welfare 
depends,  or  seems  to  depend.  In  the  long  ages  of  sav- 
agery and  barbarism  primitive  man  was  engaged  in  a  cease- 
less struggle  with  nature  for  the  bare  means  of  existence 
—  food,  clothing,  and  shelter.  Limited  as  were  the  sup- 
plies afforded  by  nature,  a  savage  tribe  never  long  en- 
joyed them  in  peace;  other  tribes  coveted  the  hunting 
grounds,  or  the  bays  where  shellfish  abounded;  the  rich 
pastures,  or  the  groves  of  fruit-bearing  trees.  Hence 
the  difficulty  of  obtaining  from  nature  the  means  of  sub- 
sistence was  aggravated  by  constant  warfare  between  tribe 
and  tribe.  A  struggle  for  mere  existence  against  nature 
and  against  hostile  tribes  —  such  was  the  life  of  primitive 
man. 

From  century  to  century  man  learned  to  equip  himself 
better  for  the  struggle  for  existence.  Tools,  at  first  rudely 
wrought  from  stone,  later  from  the  metals,  greatly  in- 
creased his  productive  power.  A  yet  greater  step  in  ad- 
vance was  made  when  animals  were  domesticated,  and  a 
certain  and  steady  food  supply  took  the  place  of  the  pre- 
carious products  of  the  chase.     The  cultivation  of  roots 

I 


2  INTRODUCTION   TO   ECONOMICS 

and  grains  that  had  in  their  wild  state  yielded  scanty  re- 
turns to  the  gatherer  marked  another  stage  of  progress. 
Methods  were  crude,  and  the  tasks  of  pastoral  and  agri- 
cultural life  exceedingly  laborious  —  a  condition  which 
gave  rise  to  the  enslaving  of  captives  taken  in  war.  With 
the  increase  in  productive  power,  limited  classes  were 
freed  from  the  economic  struggle  and  were  enabled  to 
devote  their  energy  to  ends  less  intimately  connected  with 
the  pursuit  of  wealth  —  politics,  literature,  art,  religious 
organization.  Every  advance  in  the  productive  power  of 
society  has  increased  the  relative  number  of  those  who 
are  free  to  engage  in  activities  that  add  nothing  to  the 
social  wealth. 

It  remains  true,  nevertheless,  that  th.e  great  majority  of 
men  are  mainly  occupied  with  the  pursuit  of  wealth.  This 
is  in  large  measure  due  to  the  fact  that  a  man's  desire  for 
material  welfare  is  capable  of  indefinite  expansion.  Merely 
to  possess  food  sufficient  to  satisfy  hunger  does  not  content 
him ;  the  food  must  be  pleasing  to  the  palate  as  well  as 
nutritious.  Warm  clothing  is  an  excellent  thing;  but  civil- 
ized man  demands  that  his  clothes  be  of  good  appearance 
as  well  as  comfortable.  A  sod  house  on  the  prairie  is  con- 
structed with  no  great  amount  of  labor  and  almost  no 
expense ;  in  such  a  house  one  may  defy  the  worst  storms 
of  winter  and  the  hottest  winds  of  summer.  Yet  the 
modern  dweller  on  the  plains  would  scorn  such  an 
abode ;  his  home  must  present  an  appearance  of  comfort 
and  prosperity.  To  stand  well  with  one's  fellows  is  to 
most  men  hardly  less  important  than  life  itself,  and  in  all 
human  history  a  chief  factor  in  winning  and  retaining  the 
esteem  of  others  has  been  the  possession  of  proper  attire 
and  other  personal  appointments.  There  is  a  standard  of 
wealth  consumption  which  each  little  group  of  associates 
in  society  is  under  some  sort  of  compulsion  to  attain.  If 
my  neighbors  and  friends  all  have  fine  houses,  I  cannot 


THE   NATURE   OF   ECONOMIC   SCIENCE  3 

enter  my  humble  dwelling  without  a  sense  of  inferiority. 
If  they  arc  well  dressed,  I  desire  to  be  equally  well  dressed. 
If  they  are  wise  or  learned  or  cultured,  I  naturally  strive  to 
emulate  them  in  this  respect  also.  But  one  cannot  be  well 
clad  or  well  housed,  one  cannot  without  great  difficulty  be 
wise  or  learned  or  cultured,  unless  one  can  command  a  fair 
amount  of  wealth,  an  amount  far  in  excess  of  the  bare  needs 
of  existence.  Under  modern  conditions  wealth  has  become 
a  means  —  though,  of  course,  not  the  only  means  —  to  most 
of  the  things  which  one  can  desire.  And  as  it  is  not  in  the 
nature  of  man  to  be  content  for  any  long  time  with  what  he 
possesses  and  what  he  has  attained,  it  is  inevitable  that  his 
desire  for  wealth,  which  is  so  potent  a  means  for  further 
attainment,  should  continue  unabated. 

2.  A  man  desires  wealth  not  only  for  tJie  satisfaetion 
that  it  may  give  himself,  hut  also  for  the  satisfaetion  it 
may  give  those  zvhose  interests  he  regards  as  his  ozvn. 

Nothing  is  more  common  than  to  stigmatize  the  desire 
for  wealth  as  a  narrowly  selfish  motive.  As  a  fact  there 
are  comparatively  few  men  who  desire  wealth  merely  for 
the  sake  of  the  personal  gratification  that  they  expect  to 
derive  from  it.  It  is  not  too  much  to  say  that  the  normal 
man  is  more  desirous  that  his  wife  and  children  should 
enjoy  the  comforts  of  wealth  than  that  he  should  enjoy 
them  himself.  There  are  some  persons  whose  desire  for 
wealth  is  animated  chiefly  by  the  needs  of  a  group  of 
persons  in  no  way  connected  with  them  by  ties  of  kinship. 
The  founders  of  free  hospitals,  orphan  asylums,  sailors' 
homes,  and  the  like  are  types  of  this  class.  Some  persons 
have  sympathies  so  broad  as  to  include  all  the  citizens 
of  a  country  within  the  group  for  whom  they  desire  the 
benefits  of  wealth.  The  greatness  of  Pericles  consisted 
partly  in  his  ardor  for  advancing  the  material  prosperity  of 
the  Athenians,  even  through  the  exploitation  of  allied 
states. 


4  INTRODUCTION   TO   ECONOMICS 

We  may  therefore  say  that  the  desire  for  wealth  ani. 
mates  the  purest  and  most  unselfish  of  men  as  well  as  the 
most  sordid.  The  desire  for  wealth  is  a  desire  for  means 
to  ends,  and  these  may  be  good  or  evil.  The  philanthropist 
who  wishes  to  found  a  home  for  invalid  children  must  have 
wealth,  just  as  the  voluptuary  who  desires  a  palace  of  all 
delights  to  please  his  jaded  senses.  The  economic  motive 
animates  both ;  very  likely  the  philanthropist  desires 
wealth  the  more  ardently.  What  differentiates  the  two  is 
the  end  which  the  wealth  is  meant  to  subserve.  To  assert, 
then,  that  all  men  are  in  great  measure  actuated  by  economic 
motives  is  not  to  assert  that  all  men  are  selfish  or  sordid. 
It  is  merely  to  assert  that  wealth  has  been  placed  between 
man  and  the  satisfaction  of  most  of  his  desires ;  that  as  he 
seeks  to  attain  any  end  whatsoever,  he  will  seek  to  possess 
the  means  to  that  end. 

3.  Wealth  consists  of  all  material  objects  and  human 
services  which  can  be  made  subject  to  mans  control  and 
upon  which  man  depends  for  tJie  satisfaction  of  his  wants. 

The  apples  in  one's  orchard  are  wealth  ;  they  are  subject 
to  one's  control,  and  their  consumption  yields  satisfaction. 
Even  if  their  owner  does  not  care  for  apples,  they  are 
wealth  to  him  if  through  exchanging  them  he  can  gain 
control  of  other  objects  capable  of  satisfying  his  wants. 
The  trees  which  bear  the  apples  and  the  land  upon  which 
they  grow  are  also  wealth,  as  they  are  necessary  means  to 
the  production  of  the  fruit.  Wealth,  then,  includes  those 
things  that  satisfy  desires  immediately,  or  consumers'  goods, 
and  those  things  that  serve  as  means  for  producing  objects 
of  immediate  desire,  ox  producers'  goods.  Both  classes  to- 
gether constitute  economic  goods. 

4.  Human  services  may  satisfy  wants  directly  or  in- 
directly. 

The  services  of  an  actor,  a  musician,  or  an  orator  result 
in  the  immediate  satisfaction  of  desire.     The  services  of  a 


TH^   NATURE    OF   ECONOMIC   SCIENCE  5 

mason,  a  plasterer,  or  a  carpenter  embody  themselves  in 
material  form.  Bricks  in  the  form  of  a  house  have  a 
utility  superior  to  that  of  an  equal  number  of  bricks  in  a 
material  yard,  and  the  measure  of  this  superiority  is  the 
measure  of  the  services  of  the  bricklayer. 

In  summing  up  the  annual  production  of  wealth  of  a 
given  country,  it  is  necessary  to  take  account  of  the  ser- 
vices yielding  immediate  satisfaction.  It  is  not  necessary 
to  take  account  of  the  services  resulting  in  the  indirect 
satisfaction  of  desires,  as  these  are  embodied  in  material 
objects,  which  are  always  taken  into  account  in  estimating 
the  production  of  wealth. 

5.  NoiJiing  can  be  zvealtJi  unless  the  total  sjipply  is  so 
narrozvly  limited  that  eveiy  part  of  it  is  necessary  to  satisfy 
existing  wants. 

The  sun  in  spring  satisfies  an  intense  want  of  mine ;  so 
also  do  showers  in  the  dry  season.  But  these  things  are 
not  part  of  my  wealth,  as  they  are  not  subject  to  my 
control.  The  air  I  breathe  satisfies  my  most  intense  want, 
but  it  is  not  wealth.  Though  my  life  depends  upon  a  con- 
stant supply  of  air,  it  cannot  be  said  to  depend  upon  any 
specific  part  of  the  existing  volume.  If  my  fire  consumes 
part  of  the  oxygen  in  the  air  of  my  room,  thus,  for  all 
practical  purposes,  destroying  the  air,  a  fresh  supply  flows 
in  through  the  open  window,  without  effort  or  thought  on 
my  part.  Since  no  particular  part  of  the  supply  of  air  is 
of  any  special  importance,  air  cannot  be  wealth. 

In  a  newly  settled  country  standing  timber  is  often  so 
plentiful  that  all  possible  need  for  it  for  firewood  or  for 
lumber  falls  far  short  of  absorbing  the  entire  supply.  In 
such  circumstances  standing  timber  can  have  no  place  in 
the  list  of  objects  composing  wealth.  If  one  man's  wood 
were  swept  by  fire  he  would  find  no  difficulty  in  securing 
timber  gratis  from  other  men.  When  land  itself  is  so 
plentiful,  relatively  to  the  need  for  it,  that  not  all  the  best 


6  INTRODUCTION   TO    ECONOMICS 

land  is  occupied,  no  man's  welfare  is  dependent  upon  his 
control  over  a  particular  tract  of  land.  If  in  the  early 
part  of  the  nineteenth  century  a  squatter  in  the  Ohio 
Valley  had  been  dispossessed  from  the  land  which  he 
occupied,  he  would  have  lost  nothing  but  the  improve- 
ments which  he  had  fixed  in  the  soil.  The  land,  there- 
fore, was  no  part  of  his  wealth. 

6.  T/ie  zuants  tJiat  endoiv  a  class  of  objects  with  the 
quality  of  wealth  may  originate  in  present  needs  or  in 
atiticipated future  needs. 

The  coal  fields  of  Utah  are  capable  of  producing  a  far 
greater  supply  of  coal  than  the  persons  who  now  have 
access  to  those  fields  can  possibly  use.  If  man  lived  in 
the  present  alone,  these  coal  fields  could  not  be  classed 
as  wealth.  But  it  is  generally  recognized  that  at  some 
future  time  the  mines  in  that  region  will  be  unable  to 
supply  all  need  for  fuel.  The  anticipated  future  need 
affects  the  present  calculations  of  men  and  leads  them 
to  class  the  coal  fields  among  the  objects  at  present  con- 
stituting wealth.  In  like  manner,  land  fit  only  for  building 
sites  in  the  vicinity  of  a  growing  city  acquires  a  place 
among  objects  of  wealth  even  when  it  is  far  in  excess  of 
the  present  needs  of  the  population.  Indeed,  far  the 
greater  part  of  the  wealth  of  a  modern  country  is  designed 
to  satisfy  future,  not  present,  needs ;  and  the  greater  the 
wealth  and  the  business  capacity  of  a  people,  the  greater 
will  be  the  provision  for  future  needs. 

7.  Value  is  the  one  property  that  all  forms  of  wealtJi  have 
in  common. 

The  various  objects  that  compose  the  wealth  of  an  in- 
dividual or  of  a  society  form  a  heterogeneous  mass,  and, 
from  a  physical  point  of  view,  have  no  characteristics  in 
common.  What  could  be  more  dissimilar,  physically  con- 
sidered, than  a  steam  engine  and  the  music  of  an  orches- 
tra.?     From  the  point  of  view  of  human  need,  however, 


THE    NATURE    OF    ECONOMIC    SCIENCE  7 

they  have  something  in  common.  Both  may  be  desired; 
and  the  desire  for  one  may  be  measured  in  terms  of  that 
for  the  other.  Both  are  valuable ;  the  one  may  be  twice 
as  valuable  as  the  other.  In  this  case  we  should  say  that 
the  one  represents  twice  as  much  wealth  as  the  other. 
Value  is  the  universal  characteristic  of  wealth,  and  it  is 
in  terms  of  value  alone  that  wealth  can  be  measured. 

8.  Economics  is  tJie  science  tvhicJi  deals  zuith  wealth  in 
its  most  general  aspect ;  namely,  its  value  aspect. 

Gold  and  silver  are  forms  of  wealth.  They  have  well 
marked  physical  characteristics  which  distinguish  each  from 
the  other  and  from  all  other  physical  objects.  These 
characteristics  are  not,  however,  of  direct  concern  to  eco- 
nomics. Each  possesses  value,  and  this  fact  is  of  immediate 
importance  to  economic  science.  That  an  ounce  of  gold 
is  worth  more  than  thirty-five  ounces  of  silver  is  an  eco- 
nomic fact ;  that  silver  is  harder  or  whiter  than  gold  is  not 
an  economic  fact.  True,  differences  in  physical  character- 
istics may  account  in  part  for  differences  in  value ;  but 
that  physical  differences  are  not  a  sufficient  explanation 
of  differences  in  value  is  clearly  shown  by  the  fact  that 
the  former  remain  constant,  while  the  latter  change  from 
day  to  day. 

There  is  a  body  of  principles  determining  the  proper 
use  of  each  form  of  iron  and  steel.  One  kind  of  steel 
may  properly  be  used  for  rails,  another  kind  may  not  be. 
These  laws  and  principles,  however,  are  not  a  part  of 
economics,  because  they  are  not  sufficiently  general. 
They  fall  properly  under  the  science  of  metallurgy.  The 
science  of  agriculture  treats  of  the  various  economic 
plants,  of  the  physical  and  chemical  properties  of  agri- 
cultural products,  of  their  distribution  over  the  earth  and 
of  the  uses  to  which  they  are  adapted.  This  science, 
however,  is  no  part  of  economics,  since  its  laws  are  opera- 
tive only  in  a  special  field.     An  inquiry  into  the  value  of 


8  INTRODUCTION   TO    ECONOMICS 

iron  or  of  corn,  or  into  the  value  of  the  indirect  goods  that 
are  employed  or  used  up  in  the  production  of  iron  or  corn, 
would  properly  fall  within  the  domain  of  economic  science. 

9.  Economic  science  derives  inajiy  of  its  premises  from 
the  laws  governing  Jiuman  wajits  or  desires. 

Economics  is  the  science  of  wealth.  Nothing  can  be 
wealth  —  that  is,  possess  value  —  unless  it  is  desired,  and 
the  degree  of  desire  determines  in  large  measure  the 
degree  of  value.  There  are  some  things  that  are  desired 
intensely  if  their  supply  is  narrowly  limited,  while,  if  their 
supply  becomes  very  great,  they  are  scarcely  desired  at 
all.  Diamonds  fall  in  this  class.  Other  things  are  not 
desired  very  intensely  even  if  their  supply  is  small ;  if  the 
supply  is  vastly  increased,  the  desire  for  each  part  of  the 
supply  is  not  greatly  reduced.  Many  kinds  of  food  fall 
in  this  class.  With  the  progress  in  wealth  some  things 
come  to  be  desired  more  intensely,  other  things  less  in- 
tensely. Objects  for  future  use  are  desired  less  intensely 
under  one  set  of  conditions  than  under  another.  We 
see,  then,  that  in  order  to  explain  values  it  is  necessary  to 
take  account  of  the  laws  governing  human  wants.  These 
laws  are  usually  grouped  by  economists  under  the  head  of 
the  "Consumption  of  Wealth." 

10.  Economics  deals  zvith  the  general  laivs  governing  the 
production  of  ivealth. 

There  are  laws"  governing  the  production  of  wealth  that 
are  operative  in  all  branches  of  industry,  or  at  any  rate,  in 
a  wide  range  of  industries.  Everywhere  we  find  a  tendency 
toward  more  narrow  specialization  of  function  on  the  part 
of  the  laborer ;  everywhere  we  see  a  tendency  to  substitute 
machine  production  for  hand  production.  In  a  large  num- 
ber of  industries  we  find  the  business  establishment  increas- 
ing in  average  size  from  decade  to  decade.  In  a  large 
number  of  industries  an  increase  in  the  amount  of  product 
may  be  had  only  at  a  disproportionate  increase  in  labor 


THE  naturb:  of  economic  science  9 

and  expense.     These  laws  and  related  ones  are  grouped  by 
economists  under  the  head  of  the  "  Production  of  Wealth." 

11.  Economics  deals  ivith  tJic  distribution  of  wealth 
amo}ig  the  dijfercnt  classes  of  tvhich  society  is  composed. 

The  most  prominent  characteristic  of  modern  industrial 
life  is  that  commodities  are  produced,  as  a  rule,  through 
the  joint  efforts  of  many  individuals.  There  was  a  time 
when  the  blacksmith  smelted  his  own  iron  and  controlled 
each  stage  in  the  process  until  the  finished  nail  or  horseshoe 
was  in  the  consumer's  hands.  To-day,  probably  a  thousand 
men  have  cooperated  in  the  production  of  even  so  simple 
an  article  as  a  horseshoe.  The  value  thus  produced  must 
be  distributed  in  some  way  among  the  various  producers 
Those  who  have  contributed  labor  receive  wages  ;  those 
who  have  contributed  capital  receive  interest.  What  de- 
termines how  large  a  share  of  the  total  value  shall  go  to 
the  laborers,  how  large  a  share  to  the  owners  of  capital .'' 
There  are  general  principles  governing  this  distribution, 
and  these  form  perhaps  the  most  interesting  and  important 
part  of  economics.  These  laws  are  grouped  by  economists 
under  the  head,  "The  Distribution  of  Wealth." 

12.  Economics  is  a  practical  science  ;  its  chief  function  is 
to  throw  light  upon  questions  of  political  policy. 

Economics  as  a  distinct  science  may  be  said  to  have 
taken  its  rise  in  studies  concerning  taxation  and  public 
finance.  In  early  modern  times  the  expenditures  of  govern- 
ment in  most  European  states  were  steadily  increasing. 
The  various  princes  vied  with  one  another  in  the  splendor 
of  their  palaces  and  in  the  number  and  brilliancy  of  their 
personal  following  ;  the  cost  of  maintaining  the  tranquillity 
of  the  nation  at  home,  and  its  dignity  and  influence  in  for- 
eign lands,  became  heavier  from  decade  to  decade.  More 
than  all,  methods  of  warfare  by  land  and  by  sea  were 
changing,  and  military  success  was  coming  to  depend  quite 
as  much  upon  the  size  of  the  war  chest  as  upon  the  valor 


10  INTRODUCTION   TO    ECONOMICS 

of  the  soldiers.  These  new  expenditures  could  be  met  only 
through  taxation  ;  accordingly,  it  became  a  very  practical 
matter  for  the  statesman  to  devise  means  for  increasing  the 
prosperity  of  a  nation  in  order  to  increase  its  capacity  for 
paying  taxes.  As  the  precious  metals  seemed  to  be  the 
most  convenient  and  the  most  stable  form  of  wealth,  it 
was  the  aim  of  the  statesman  to  provide  these  in  abundance. 
European  countries,  having  no  important  mines  of  silver 
and  gold,  could  secure  these  metals  only  through  foreign 
trade.  Hence  the  kernel  of  early  modern  economic  policy 
was  the  regulation  of  foreign  trade,  with  a  view  to  bringing 
into  a  country  large  supplies  of  treasure.  These  regula- 
tions formed  a  system  which  in  the  end  became  burdensome 
in  the  extreme;  their  futility  and  injuriousness  were  ex- 
posed in  the  latter  half  of  the  eighteenth  century  by  the 
Economistes  in  France  and  by  Adam  Smith  in  Great  Britain, 
whose  writings  first  placed  economics  on  a  scientific  basis. 

Through  the  nineteenth  century  economic  discussion  has 
progressed  from  one  practical  problem  to  another  — -  money 
and  banking,  trade  unionism,  socialism,  monopoly,  etc. 
The  chief  function  of  the  science  is  still,  as  in  its  earliest 
period,  to  ascertain  what  economic  policy  of  government 
will  be  most  conducive  to  the  general  welfare.  Although 
it  is  known  as  the  "science  of  wealth,"  it  is  not  the  func- 
tion of  economics  to  instruct  individuals  how  they  may  best 
acquire  wealth.  Its  principal  aim  has  been  attained  when 
it  has  thrown  all  possible  light  upon  the  economic  prob- 
lems which  a  state,  and  its  members  as  citizens  of  a  state, 
may  need  to  solve. 

13.  Most  of  the  political  problems  of  the  present  time  are 
economic  in  tJicir  Jiatiire. 

The  importance  of  economics  to  the  citizen  of  a  modern 
state  is  clearly  seen  when  we  enumerate  the  issues  that 
have  held  a  prominent  place  in  national  politics.  In  the 
presidential  campaign  of  1908,  revision  of  the  tariff,  regu- 


THE    NATURE    OF    ECONOMIC    SCIENCE  ii 

lation  of  business  corporations,  and  reform  of  our  banking 
system,  were  among  the  most  important  subjects  of  dis- 
cussion. All  these  questions  are  almost  purely  economic 
in  their  nature.  The  money  question,  the  labor  question, 
the  railway  problem,  speculation  and  crises,  are  further 
economic  problems  upon  which  every  citizen  ought  to  be 
able  to  form  an  intelligent  opinion. 

Most  of  us  have  at  some  time  speculated  upon  the  apparent 
injustice  in  the  distribution  of  rewards  and  services  under 
the  existing  economic  system.  Is  it  right  that  the  unskilled 
laborers,  whose  hours  are  long,  and  whose  toil  is  hard  and 
uninteresting,  should  receive  only  the  smallest  pittance,  while 
the  successful  lawyer  or  architect  receives  a  princely  income 
for  work  that  may  afford  him  the  greatest  pleasure  .''  Many 
able  thinkers  have  utterly  condemned  the  existing  economic 
system  because  of  this  inequality  of  rewards  ;  they  would 
substitute  a  plan  of  sharing  which  would  give  to  each  accord- 
ing to  the  time  spent  or  according  to  the  degree  of  exertion. 
Certainly,  this  would  increase  the  welfare  of  many  who 
now  have  far  too  little;  it  might  not  seriously  injure  those 
who  have  more  than  is  necessary  for  comfortable  existence. 
Yet  could  such  a  change  be  made  without  setting  in  motion 
influences  which  in  the  end  would  leave  the  rich  poor  and 
the  poor  more  wretched  than  they  now  are  ?  The  question 
is  one  that  cannot  be  answered  without  a  thorough  study 
of  the  laws  governing  the  production  and  distribution  of 
wealth  under  modern  conditions. 

It  is  now  clear  why  economic  study,  though  of  recent 
origin,  is  prosecuted  w'th  more  zeal  than  almost  any  other 
department  of  science.  It  is  concerned  with  one  of  the  most 
vitalof  all  subjects — the  general  welfare.  Without  economic 
science  the  existing  constitution  of  society  cannot  be  under- 
stood ;  unless  based  upon  an  adequate  understanding  of 
economic  laws,  attempts  at  practical  reform  of  recognized 
evils  are  likely  to  do  more  harm  than  good. 


12  INTRODUCTION   TO   ECONOMICS 

14.  Economics  must  ever  remain  a  developing  body  of 
thought,  sijice  economic  life,  which  it  is  designed  to  explain, 
is  constantly  changing. 

Had  a  Greek  philosopher  attempted  a  systematic  treatise 
on  economics,  we  should  find  in  it  comparatively  little  that 
would  assist  us  in  solving  the  problems  of  to-day.  Such  a 
treatise  would  have  dwelt  at  length  upon  the  proper  man- 
agement of  slaves,  and  the  principles  governing  their  value. 
It  would  have  paid  slight  attention  to  the  principles  gov- 
erning wages,  since  free  labor  was  comparatively  unimpor- 
tant in  ancient  Greece.  It  would  have  devoted  very  little 
space  to  capital  and  interest,  as  capital  was  slightly  devel- 
oped, and  the  taking  of  interest  an  infrequent  phenomenon. 
Even  exchange  value,  or  price,  would  have  received  scant 
attention,  since  most  commodities  were  consumed  by  the 
producer,  instead  of  being  placed  on  the  market,  as  to-day. 
So  we  may  assume  that  the  economic  science  of  the  present 
day  will,  some  hundred  years  hence,  prove  almost  devoid 
of  practical  interest.  The  economics  of  each  generation 
must  be  based  upon  the  prevailing  system  of  wealth  pro- 
duction and  distribution. 

15.  The  fundamental  characteristic  of  the  existing  eco- 
nomic system  is  that  men  produce  goods,  not  for  their  own 
use,  but  for  sale. 

Throughout  the  periods  of  savagery  and  barbarism  men 
lived  in  small  groups,  which  produced,  through  the  chase, 
agriculture,  and  pasturage,  practically  everything  that  the 
members  of  the  group  consumed.  Whether  the  group 
prospered  or  fared  ill  depended  upon  the  weather,  the  fer- 
tility of  the  soil,  the  quantity  and  character  of  game,  the 
relation  to  other  groups  —  whether  tribute  was  given  or 
received.  Within  the  group  the  relative  welfare  of  each 
member  depended  to  a  certain  extent  upon  his  own  prowess 
and  efficiency  ;  perhaps  to  a  greater  extent  upon  the  tribal 
customs  in  accordance  with  which  the  common  products 


THE   NATURE   OF   ECONOMIC    SCIENCE  13 

of  the  group  were  distributed  among  its  members.  In  the 
civilized  states  of  antiquity  a  somewhat  similar  condition 
of  affairs  existed.  Industry  was  based  on  slavery;  the 
lord  of  landed  estates  produced  by  slave  labor  almost 
everything  that  was  needed  on  the  estate.  I  lis  welfare 
depended  upon  the  amount  and  fertility  of  the  land  he 
possessed,  the  number  of  his  slaves  and  his  skill  in  man- 
aging them,  the  state  of  the  weather,  and  freedom  from 
hostile  invasion.  So,  also,  in  the  mediaeval  villages.  They 
were  self-sufficing;  the  welfare  of  the  community  depended 
upon  natural  forces  and  the  energy  of  the  members  of  the 
community  and  their  capacity  for  cooperation.  Each  in- 
dividual depended  for  his  welfare  partly  upon  the  same 
conditions,  partly  upon  village  custom  in  the  apportion- 
ment of  services  and  rewards. 

With  the  rise  of  modern  trade  a  significant  change  took 
place  in  economic  life.  In  greater  and  greater  measure 
men  engaged  in  production  for  distant  markets,  instead  of 
for  their  own  use.  Under  such  conditions  welfare  de- 
pended not  only  upon  the  producer's  energy  and  success 
in  the  creation  of  goods.  It  depended  also  in  large  meas- 
ure upon  the  price  of  the  goods  which  were  sent  to  market. 
The  transition  from  production  for  one's  own  use  to  pro- 
duction for  the  market  took  place  at  various  times  in 
different  countries  and  in  different  industries.  In  some 
branches  of  production  it  is  only  recently  that  the  change 
has  been  effected.  Thus  the  production  of  bread,  formerly 
almost  everywhere  carried  on  in  the  household  for  con- 
sumption there,  has  in  the  cities  become  an  independent 
branch  of  industry,  carried  on  for  supplying  a  market,  just 
as  the  production  of  shoes,  cloth,  or  iron. 

The  striking  characteristic  of  modern  economic  life,  then, 
is  that  men  produce  goods  for  the  market.  The  employee 
in  a  shoe  factory  will  very  probably  never  wear  any  of  the 
shoes  he  helps  to  produce ;  if  the  maker  of  clothes  ever 


14  INTRODUCTION   TO   ECONOMICS 

works  on  garments  for  himself,  this  is  the  exception  to  the 
rule  of  his  daily  labor.  The  farmer  consumes  little,  if  any, 
of  the  wheat  that  he  raises  ;  the  woolgrower  rarely  spins 
and  works  up  into  cloth  for  his  own  use  the  product  of  his 
flocks.  The  modern  economic  system  is  therefore  called 
an  exchange  economy,  for  it  is  through  exchange  of  goods 
that  each  man  gets  the  commodities  that  he  needs.  And 
with  the  rise  of  the  exchange  economy  a  new  set  of  laws 
of  wealth  and  welfare  have  come  into  operation.  The 
welfare  of  a  farmicr  under  modern  conditions  depends  in 
some  degree  upon  his  own  energy  and  intelligence,  and  in 
some  degree  upon  the  weather.  But  in  a  very  large  de- 
gree it  depends  upon  the  price  at  which  he  can  sell  his 
products.  A  high  price  of  iron  brings  prosperity  to  all  the 
classes  engaged  in  the  production  of  iron,  as  a  low  price 
involves  them  in  loss  and  distress. 

16.  A  second  cJiaracteristic  of  tlic  viodern  economic  system 
is  competition  in  the  sale  and  pnrcJiase  of  goods. 

When  men  first  began  to  produce  goods  for  sale,  we  may 
suppose  that  they  had  fairly  definite  views  as  to  the  mini- 
mum price  they  would  take  and  the  maximum  which  they 
might  reasonably  seek,  and  that  the  margin  between  mini- 
mum and  maximum  was  not  wide.  At  any  rate  we  know 
that  in  mediaeval  times  the  producer  was  animated  by  the 
ideal  of  a  fair  and  just  price;  to  demand  more  than  this 
was  extortion  ;  to  accept  less  was  a  humiliation.  This  spirit 
prevailed,  however,  only  in  dealings  with  fellow-townsmen. 
To  compel  strangers  to  pay  more  than  a  fair  price,  and  to 
force  strangers  to  accept  less  than  a  fair  price  for  their 
wares,  was  regarded  as  entirely  legitimate.  As  trade  de- 
veloped it  assumed  more  and  more  the  character  of  trade 
between  strangers,  each  party  to  a  transaction  seeking  to 
gain  the  largest  possible  benefit  from  it. 

Naturally  that  buyer  was  in  the  most  favorable  position 
who  could  pit  one  seller  against  another.    Each  seller  would 


T?IE    NATURE    OF    ECONOMIC    SCIENCE  15 

be  forced  to  scale  down  his  prices  lest  the  other  seller  con- 
summate an  advantageous  bargain.  Similarly,  that  seller 
was  fortunate  who  could  pit  one  buyer  against  another. 
This  was  competition  in  its  crudest  form.  In  this  form  it 
exists  to-day  in  auction  rooms,  stock  exchanges,  and  in  cer- 
tain branches  of  retail  trade. 

A  seller  may  find  himself  alone  in  the  presence  of  a 
buyer,  yet  both  may  be  subject  to  the  influence  of  compe- 
tition. The  seller  knows  that  the  buyer  can  probably  find 
another  seller  of  the  same  or  similar  wares ;  the  buyer 
knows  that  the  seller  can  find  other  buyers.  Accordingly, 
the  action  of  each  is  controlled,  in  a  measure,  by  the  possi- 
ble action  of  persons  who  are  not  present  and  have  no 
knowledge  of  the  particular  transaction  in  which  they  are 
engaged.  This  form  of  competition  is  more  or  less  effec- 
tive according  to  the  number  of  transactions  of  a  given 
kind  occurring  in  a  community.  No  grocer  can  sell  sugar 
for  a  price  much  in  excess  of  that  fixed  by  other  grocers  ; 
no  farmer  can  hold  out  for  an  excessively  high  price  for 
his  wheat.  The  seller  of  an  old  mansion  is  less  narrowly 
limited  in  his  demands  by  competition  of  this  kind,  as  the 
buyer  must  choose  between  the  mansion  and  some  other 
kind  of  house.  On  the  whole,  it  may  be  said  that  with  the 
development  of  industry  a  constantly  greater  proportion  of 
the  goods  bought  and  sold  are  of  such  a  character  that 
competition  enters  into  the  determination  of  their  prices. 

Competition  may  assume  a  yet  subtler  form.  In  small 
towns  petty  dealers  often  evince  a  spirit  of  hostihty  to 
the  occasional  circus,  because  the  circus  "  takes  money 
away  from  the  town."  It  is  clear  that  the  money  spent  at 
the  circus  cannot  be  spent  for  candy  and  soda  water  and 
other  similar  goods.  The  circus  is  thus  really  a  competitor 
of  the  petty  trader.  The  latter  must  give  goods  of  better 
quaUty,  or  goods  at  lower  prices,  to  prevent  pennies  from 
being  hoarded  for  circus  day.     The  principle  involved  in 


l6  INTRODUCTION   TO   ECONOMICS 

this  illustration  is  that  every  seller  is  a  competitor  of  every 
other  seller ;  every  buyer  of  every  other  buyer.  An  ex- 
change economy  inevitably  entails  competition. 

17.  Competition  is  always  subject  to  more  or  less  conscious 
restraint.      Wliere  this  restraint  is  ejfective,  monopoly  exists. 

In  mediaeval  and  early  modern  times  the  producers  and 
traders  of  each  town  claimed  the  right  to  exclude  strangers 
from  buying  or  selling  within  the  town,  except  under  re- 
strictions that  effectively  prevented  them  from  competing 
for  the  ordinary  trade  of  the  town.  Each  citizen  was  com- 
pelled by  law  and  custom  to  refrain  from  acts  that  would 
impair  his  fellow-citizens'  chances  of  securing  "  fair  prices." 
Early  modern  trade  with  barbarous  and  half-civilized  peo- 
ples was  also  carried  on  under  regulations  calculated  to 
restrain  competition.  Each  European  country  claimed  the 
exclusive  right  of  trading  with  certain  regions  —  Spain 
with  Spanish  America,  England  with  British  America  and 
parts  of  the  East  Indies,  Holland  with  the  Dutch  East 
Indies,  etc.  Nor  were  all  citizens  of  these  countries 
permitted  to  participate  in  the  trade  with  their  respective 
colonies ;  companies  of  traders  were  formed  and  were 
given  exclusive  privileges,  insuring  them  the  benefits  of 
non-competitive  conditions.  In  recent  years  every  modern 
nation  has  witnessed  the  formation  of  combinations  of  pro- 
ducers with  the  object  of  limiting  competition.  Many  of 
these  combinations  are  successful  in  controlling,  to  a  certain 
extent,  the  prices  of  their  products.  These  combinations 
are  popularly  known  as  monopolies.  They  are  none  the 
less  subject  to  the  form  of  competition  last  described  in 
the  foregoing  section. 

18.  A  third  characteristic  of  the  modern  economic  system 
is  the  formation  of  classes  based  upon  economic  function. 

Every  society  which  has  passed  beyond  the  most  primi- 
tive stage  has  been  composed  of  classes.  Master  and  slave, 
lord  and  serf,  Norman  and  Saxon  —  such  are  some  of  the 


THE   NATURE    OF    ECONOMIC    SCIENCE  17 

class  distinctions  with  which  history  has  familiarized  us. 
Under  modern  conditions  class  distinctions  are  formed  on 
other  lines.  One  class  of  men  gain  their  livelihood  by  labor ; 
another  by  the  ownership  of  property  ;  a  third  by  placing 
labor  and  wealth  in  productive  combinations  —  laborers, 
capitalists,  and  enterprisers.  This  differentiation  of  classes 
is  by  no  means  complete,  and  probably  never  will  be. 
Most  laborers  own  a  little  property  ;  most  capitalists  per- 
form labor ;  most  enterprisers  are  at  the  same  time  both 
laborers  and  capitalists.  Nevertheless,  the  differentiation 
is  clearly  enough  marked  for  all  practical  purposes.  It  is 
a  natural  result  of  modern  conditions  of  production.  So 
long  as  each  man  produced  goods  for  his  own  use,  the 
tools  and  appliances  which  he  used  were  of  necessity  sim- 
ple. To  cut  enough  wood  for  one's  own  use  did  not  re- 
quire a  very  expensive  ax ;  to  furnish  boards  for  one's 
own  dwelling  required  only  a  handsaw,  to  be  worked  by 
two  men.  Spinning  wheels  and  looms  were  likewise  of 
the  simplest  make.  These  tools  and  appliances  could  be 
made  by  the  workman  himself,  or  secured  through  ex- 
change at  small  sacrifice.  Accordingly,  the  laborer  as  a 
rule  owned  the  implements  he  worked  with.  In  early 
modern  times,  although  production  for  the  market  had  be- 
come fairly  common,  the  means  of  production  still  remained 
in  the  worker's  hands.  The  increasing  demand  for  prod- 
ucts, however,  soon  led  to  the  introduction  of  more  ex- 
pensive tools,  and  at  last  to  the  invention  of  machinery. 
Every  step  in  this  direction  made  it  more  difficult  for  the 
worker  to  provide  himself  with  the  means  of  production. 
So  these  had  to  be  supplied  by  persons  of  wealth — capi- 
talists. Under  present  conditions  manufacturing  industry 
in  almost  all  its  branches  requires  so  large  an  expenditure 
for  equipment  that  no  single  laborer  can  own  the  tools  and 
machines  he  works  with  ;  nor  is  it  possible  for  a  group  of 
laborers  to  equip  themselves  for  production  through  com- 


i8  INTRODUCTION  TO   ECONOMICS 

bining  their  small  savings.  The  capital  outlay  for  a  mill 
employing  a  hundred  workmen  is  usually  far  in  excess  of 
what  a  hundred  workmen  can  accumulate.  Industry  must 
therefore  be  conducted  by  wage  laborers  and  employer- 
capitalists.  In  many  cases  those  who  possess  capital  are 
not  in  a  position  to  use  it  in  business.  These  persons  form 
a  class  fairly  distinct  from  those  persons  who  actively  en- 
gage in  the  conduct  of  business. 

19.  TIic  laws  of  price  arc  the  governing  principle  in  mod- 
ern economic  life. 

A  farmer  or  a  manufacturer  is  popularly  said  to  "  put  a 
price  "  upon  his  products.  In  tlie  majority  of  cases,  how- 
ever, what  the  seller  really  does  is  to  make  a  choice  be- 
tween selling  at  a  given  price  or  keeping  his  goods  unsold. 
Except  in  comparatively  rare  cases  there  is  a  market  price 
for  goods  which  the  buyers  and  sellers  must  accept  if  they 
desire  to  engage  in  business  at  all,  and  over  this  price 
no  single  person  has  any  perceptible  control.  Yet  prices 
do  not  exist  apart  from  the  action  of  men  ;  they  are  the 
creation  of  man  in  society.  Many  persons,  each  acting 
with  a  view  to  his  own  interest,  offer  wheat  for  sale  ; 
many  persons  stand  ready  to  buy  it.  The  price  of  wheat 
is  fixed  as  a  result  of  the  offers  and  demands  of  all  per- 
sons who  sell  or  buy  wheat.  It  is  therefore  a  social  phe- 
nomenon—  the  creation  of  all  society,  or  of  a  large  part  of 
it.  And  so  it  is  with  almost  all  prices.  They  are  set  by 
society.  Hence  the  laws  of  price  are  properly  called  the 
laws  of  social  economics,  or  of  political  economy. 

Under  modern  conditions  the  prosperity  of  each  in- 
dustry as  a  whole  depends  largely  upon  the  prices  of  its 
products.  Within  each  industry  the  prosperity  of  each 
laborer,  capitalist,  or  employer  depends  in  great  degree 
upon  the  way  in  which  the  total  product  of  the,  industry 
is  divided.  And  here  again  we  encounter  social  laws. 
There  is  a  general  rate  of  wages,  which  the  laborer  must 


THE   NATURE   OF   ECONOMIC   SCIENCE  19 

accept  if  he  wishes  employment.  In  the  same  way,  there 
is  a  general  rate  of  interest.  No  one  man  exercises  an}'' 
appreciable  influence  in  fixing  these  rates;  they  are  the 
resultant  of  the  actions  of  all  those  who  have  labor  to  sell 
or  capital  to  lend,  on  the  one  hand,  and  on  the  other  hand, 
of  those  who  desire  to  hire  laborers  or  to  borrow  capital. 

The  influence  of  price  extends  even  further.  In  large 
measure  the  laws  of  price  determine  what  each  of  us  shall 
do ;  they  fix  one's  place  of  residence  as  well  as  his  occupa- 
tion. If  the  price  of  glass  is  high,  and  remains  high  for  a 
considerable  period  of  time,  high  profits  and  high  wages 
are  possible  in  the  glass  industry.  New  establishments 
will  be  opened ;  boys  and  young  men  who  otherwise 
would  have  engaged  in  other  industries  become  glass  blow- 
ers. By  fixing  a  high  price  on  glass,  society,  as  it  were, 
decrees  that  more  persons  and  more  capital  shall  be  de- 
voted to  that  industry.  If  coal  and  other  sources  of  power 
are  exceptionally  cheap  in  a  given  locality,  if  conditions  of 
transportation  are  exceptionally  favorable,  large  profits 
may  be  made  by  manufacturers  in  that  locality  ;  they 
increase  their  investments  and  new  capital  flows  in  from 
less  favored  districts.  A  city  is  built,  and  the  population 
that  was  formerly  scattered  in  hamlets  and  country  is  under 
a  sort  of  compulsion  to  congregate  there.  Why  are  our 
cities  becoming  greater  and  greater  ?  The  social  laws  of 
price  decree  it.  If  we  would  understand  just  why  modern 
society  presents  a  given  form,  our  inquiry  must  take  into 
account,  as  perhaps  the  most  important  factor,  these  laws 
of  price. 

20.    S?immary. 

Economics  is  the  science  which  treats  of  wealth — the 
material  objects  and  human  services  which  contribute  to 
human  welfare,  and  are  therefore  valued.  The  history  of 
mankind  is  largely  a  record  of  progress  in  the  power  of 
producing  wealth  and  the  development  of  institutions  for 


20  INTRODUCTION   TO   ECONOMICS 

the  distribution  of  wealtli  among  the  individuals  composing 
society. 

Economic  science  begins  with  a  study  of  the  desires 
which  give  rise  to  economic  activity  and  the  values  which 
originate  in  these  desires.  It  deals,  further,  with  the  gen- 
eral laws  governing  the  production  of  wealth  and  its  distri- 
bution among  the  various  classes  in  society.  The  practical 
object  of  the  science  is  the  establishing  of  principles  upon 
which  organized  society  must  act  in  order  to  increase  the 
general  well-being. 

The  economic  problems  of  any  historical  period  can  be 
understood  only  with  reference  to  the  underlying  condi- 
tions characterizing  the  economic  life  of  that  period.  In 
order  to  appreciate  the  significance  of  modern  economic 
problems,  it  is  necessary  to  ascertain  the  fundamental  char- 
acteristics of  modern  economic  life.  These  are:  (i)  Pro- 
duction, of  goods  and  services,  not  for  the  use  of  the 
producer,  but  for  sale ;  (2)  Competition  in  the  purchase 
and  sale  of  goods  and  services;  (3)  The  existence  of 
classes  based  upon  economic  function  —  laborers,  capital- 
ists, and  enterprisers.  The  last  two  characteristics  are,  in 
a  sense,  corollaries  of  the  first. 

The  key  to  an  understanding  of  the  existing  economic 
system  is  to  be  found  in  the  laws  governing  the  prices  of 
commodities  and  services.  The  prices  of  goods  are  for  the 
most  part  beyond  the  control  of  individuals;  they  may  be 
said  to  be  determined  by  society  as  a  whole.  The  laws  of 
price  are  therefore  properly  described  as  social  laws ;  and 
the  body  of  thought  dealing  with  these  laws  is  known  as 
social  economics. 


CHAPTER    II 

UTILITY,    VALUE,  AND   PRICE 

1.  Economic  evolution  is,  in  lai'ge  measure,  dcpejident 
upon  the  developinent  of  zvants. 

Man  is  distinguished  from  all  other  living  creatures  by 
the  number  and  complexity  of  his  wants.  The  lowest 
savage  requires  better  shelter  and  more  varied  and  nutri- 
tious food  than  his  next  of  kin  in  the  animal  world.  The 
wants  of  the  savage  are,  however,  few  and  simple  as  com- 
pared with  those  of  civilized  man.  An  extraordinary  run 
of  fish,  an  exceptionally  good  season  for  game,  may  leave 
the  savage  with  all  his  wants  practically  satisfied.  Men 
who  have  had  occasion  to  employ  workmen  of  half-civilized 
races  complain  that  as  soon  as  the  workman  has  received 
wages  enough  to  supply  his  wants  for  a  few  days,  he 
ceases  to  take  interest  in  his  work,  and  very  soon  quits 
his  employment,  to  resume  it  again  only  when  driven  by 
the  goad  of  hunger.  Civilized  man,  on  the  other  hand, 
seldom  suffers  from  lack  of  means  to  satisfy  hunger;  he 
is,  however,  constantly  aware  of  some  want  that  remains 
unsatisfied,  and  the  higher  the  state  of  civilization,  the 
greater  the  number  of  wants  that  are  effective  enough  to 
incite  a  man  to  activity.  The  normal  man  in  an  American 
city  limits  his  toil  only  when  he  feels  that  this  is  necessary 
in  order  to  preserve  his  powers  for  future  labor.  Even  our 
pleasures  are  selected  largely  with  a  view  to  increasing  our 
working  capacity. 

Not  only  do  the  wants  of  civilized  man  impel  him  to 
work  harder  than  a  savage  would  work ;  they  also  force 
him  to  take  more  careful  thought  in  the  application  of  his 
energies.     Hence  the  invention  of  new  appliances  for  pro- 

2X  i 


22  INTRODUCTION    TO    ECONOMICS 

duction  and  better  methods  of  organizing  and  directing 
productive  povyer.  As  a  rule,  the  more  numerous  and 
complex  the  wants  of  an  individual,  the  greater  are  his 
exertions  and  the  higher  the  skill  and  intelligence  with 
which  his  energies  are  directed. 

2.  Human  ivaiits  diffej'  ividcly  hi  elasticity,  the  wants 
for  luxuries  being  more  elastic  than  the  ivants  for  neces- 
saries. 

Every  want  of  man  is  capable  of  complete  satisfaction. 
But  the  different  wants  vary  widely  in  their  insistency  and 
in  the  ease  with  which  they  may  be  entirely  satisfied.  The 
want  for  bread,  for  instance,  is  extremely  insistent,  yet  easily 
satisfied.  I  must  have  bread,  but  I  would  not  care  to  have 
even  a  petty  baker's  entire  supply.  Such  a  want  is  known 
in  economics  as  an  inelastic  one.  The  people  of  the  United 
States  require  a  fairly  determinate  quantity  of  wheat  for 
food,  and  this  quantity  they  will  strive  to  secure  even  at 
great  sacrifice.  Much  more  than  this,  however,  would  not 
be  wanted  at  all,  unless  of  course  it  could  be  sold  in  other 
lands,  or  some  use  other  than  the  supplying  of  food  could 
be  found,  for  it.  On  the  other  hand,  the  want  for  some 
classes  of  things  is  very  hard  to  satisfy  at  all,  although 
it  is  not  absolutely  essential  that  the  want  be  satisfied. 
I  can  get  on  very  well  without  possessing  paintings,  but  I 
should  like  to  have  all  there  are  in  the  Louvre.  The  peo- 
ple of  the  United  States  may  live  comfortably  without 
having  many  art  galleries,  but  it  is  almost  inconceivable 
that  they  could  have  too  many.  Such  wants,  then,  are 
elastic. 

As  the  examples  given  indicate,  it  is  the  wants  for  so- 
called  necessaries  that  are  inelastic ;  the  wants  for  luxuries 
are  elastic.  Civilization  tends  to  develop  the  wants  for  lux- 
uries of  all  kinds.  Hence,  it  may  be  said  that  the  higher  a 
people  stands  in  the  scale  of  civilization,  the  farther  it  is 
from  the  complete  satisfaction  of  all  its  wants. 


UTILITY,    VALUE,   AND    PRICE  23 

3.  When  a  want  is  satisfied  by  the  consumption  of  a  sue 
cession  of  similar  goods,  the  satisfaction  derived  from  the 
first  good  consumed  is  greater  than  that  derived  from  the 
second,  and  that  derived  from  succeeding  goods  grows 
steadily  less.  This  principle  is  known  as  the  law  of  diniiii- 
ishing  intensity  of  wants. 

Every  man  wants  enough  food  to  keep  him  alive;  a 
quantity  sufficient  for  this  purpose  he  desires  intensely. 
An  equal  additional  quantity  will  keep  him  in  good  condi- 
tion ;  this  quantity  he  desires  only  less  intensely.  Give  him 
more  food  ;  it  may  still  please  his  palate,  and  satisfy  a  want. 
But  a  point  is  soon  reached  where  the  man  wants  no  more 
food  at  all. 

So  the  want  for  a  suit  of  clothes  is  hardly  less  insistent 
than  the  want  for  food  enough  for  life.  A  second  suit  of 
clothes  would  be  highly  desired,  even  if  of  identical  quality, 
as  it  may  be  worn  when  the  first  is  soaked  with  rain  or 
otherwise  out  of  condition  for  wear.  A  third  suit  of  the 
same  kind  would  not  be  desired  very  intensely  ;  a  fourth, 
or  at  any  rate  a  fifth  or  sixth,  would  be  a  superfluity.  But 
if  it  is  possible  to  vary  tiie  quality,  the  want  becomes  far 
more  expansive.  The  social  element  becomes  predomi- 
nant ;  the  man  would  dress  at  least  as  well  as  men  in  the 
social  group  to  which  he  belongs,  or  of  which  he  desires 
to  become  a  member.  Yet  a  point  is  eventually  reached 
where  neither  increase  in  quantity  nor  improvement  in 
quality  is  desired. 

It  may  then  be  stated,  as  one  of  the  general  laws  of 
human  nature,  that  each  want  is  capable  of  varying  degrees 
of  satisfaction,  that  with  each  increase  in  the  means  of 
satisfaction  the  desire  for  additional  means  grows  less, 
until  a  point  is  reached  where  want  is  no  longer  felt. 

4.  The  capacity  of  a  good  for  satisfying  wants  is  knoivn 
as  iitility. 

Whatever  satisfies  a  want  is  a  good,  in  economic  termi- 


24  INTRODUCTION   TO    ECONOMICS 

nology.  The  power  of  a  good  to  satisfy  wants  is  utility 
It  is,  of  course,  plain  that  nothing  has  utility  in  this  sense 
unless  it  is  wanted.  Utility  is  strictly  parallel  with  want; 
human  want  for  a  certain  object  endows  it  with  utility, 
and  the  degree  of  utility  is  measured  by  the  degree  of 
want.  Before  men  knew  the  use  of  iron,  iron  ore  had  no 
utility  at  all ;  with  every  advance  in  the  art  of  metallurgy, 
the  utility  of  iron  ore  has  increased.  In  the  days  of  Marco 
Polo,  the  only  utility  that  existed  in  the  petroleum  of  Asia 
Minor  arose  from  its  use  "  to  anoint  camels  suffering  from 
the  mange";  now  the  progress  of  science  and  industry 
has  endowed  the  same  material  with  a  very  high  'utility. 

The  same  object  may  have  far  greater  utility  under  one 
set  of  circumstances  than  under  another.  A  tree  on  a 
mountain  side  may  have  utility  as  it  stands,  derived,  of 
course,  from  some  prospective  use.  This  utility'  may  be 
called  elementary  utility.  When  the  tree  is  felled  and  car- 
ried by  a  stream  to  a  saw-mill,  its  utility  is  increased  by 
mere  change  of  place.  This  addition  to  the  utility  of  the 
tree  may  be  csWedplace  utility.  A  further  increase  in  util- 
ity appears  when  the  log  is  transformed  into  boards.  This 
increase  is  known  2isfonn  utility.  If  the  boards  should  be 
kept  in  a  lumber  yard  for  ten  years,  very  likely,  on  account 
of  the  failing  supply  of  timber,  their  utility  would  be  con- 
siderably increased.  This  increase  may  be  called  time 
utility.  It  is  to  be  remembered,  however,  that  the  forego- 
ing terms  do  not  represent  different  kinds  of  utility,  but 
relate  to  the  conditions  under  which  utility  comes  into  exist- 
ence. Utility  is  the  single,  uniform  quality  of  want-satis- 
fying power. 

Utility,  it  is  to  be  borne  in  mind,  is  not  usefulness. 
Opium  prepared  for  smoking,  being  ardently  desired  by 
the  victims  of  the  opium  habit,  has  a  very  high  utility,  in 
the  economic  sense ;  but  it  is  the  reverse  of  useful.  As  a 
rule,  whatever  is  useful  has  utility,  but  there  is  no  close 


UTILITY,    VALUE,   AND    PRICE  25 

correspondence  between  the  degree  of  usefulness  and  the 
degree  of  utiHty. 

5.  W/icii  a  man  acquires  goods  of  the  same  kind  one  by 
one,  the  utility  of  the  first  good  acquired  exceeds  that  of  the 
second,  the  utility  of  the  second  good  exceeds  that  of  the 
third,  and  so  on,  each  successive  good  represoiting  a  smaller 
utility.  This  principle  is  knoivn  as  the  laiv  of  diminisli- 
ing  utility. 

We  have  seen  that  wants  are  capable  of  varying  degrees 
of  satisfaction.  As  utility  is  strictly  parallel  with  want, 
concrete  goods,  satisfying  the  different  degrees  of  want, 
have  different  degrees  of  utility.  Three  bushels  of  wheat 
may  supply  me  with  bread  enough  to  sustain  life  through 
a  year;  the  utility  of  these  three  bushels  —  supposing  I 
have  no  other  source  of  food  supply  —  is  exceedingly  great ; 
I  want  them  as  I  want  life  and  all  that  life  contains.  It 
would  not  be  easy  to  fix  an  estimate  upon  this  amount  of 
utility,  but  let  us 'call  it  iooo,r.  Another  three  bushels 
would  enable  me  to  keep  in  fairly  good  physical  condition  ; 
but  their  utility  to  me  is  evidently  less  ;  perhaps  it  would 
be  100, I'.  Another  three  bushels  might  mean  overfeeding; 
yet  some  persons  are  desirous  of  being  overfed ;  hence  I 
may  still  desire  these  three  bushels,  and  thus  endow  them 
with  utility,  which  may  possibly  be  measured  by  \ox. 
With  another  three  bushels  I  might  feed  a  cat  and  a  dog ; 
it  would  give  me  pleasure  to  have  these  as  pets  ;  therefore 
I  should  desire  the  additional  supply  of  wheat,  and  it 
might  represent  a  utility  of  5  x.  An  additional  three  bush- 
els I  could  probably  not  use  in  any  way  giving  me  satis- 
faction.    They  would  have  no  utility  for  me  at  all. 

Suppose  that  I  find  a  particularly  beautiful  seashell. 
As  it  seems  beautiful  to  me,  it  has  utility  to  me.  The 
amount  of  utility  may  equal  lOj'.  Another  shell  will  not 
be  so  much  of  an  acquisition,  but  I  shall  still  desire  it. 
Its  utility  may  perhaps  be  9  j.     Additional  ones  will  give 


26  INTRODUCTION   TO   ECONOMICS 

me  less  pleasure,  but  as  the  want  for  things  of  beauty  is 
hard  to  satisfy,  I  may  still  experience  a  desire  for  a  hun- 
dredth or  a  thousandth  shell,  and  these  would  have  some 
utility  for  me.  There  is,  however,  a  point  beyond  which 
additional  shells  would  merely  cumber  my  premises; 
they  would  then  have  no  utility. 

These  examples  assume,  of  course,  that  I  do  not  undergo 
a  change  while  I  am  acquiring  these  goods.  If  repeated 
examination  of  the  seashell  inspires  me  with  an  increasing 
sense  of  its  perfection  of  form,  I  may  desire  a  second  even 
more  than  I  desired  the  lirst.  Its  utility  will  be  greater 
than  that  of  the  first  originally  was,  but  not  greater  than 
the  utility  of  a  first  shell  would  be  in  my  present  state. 

So  one's  first  experience  of  classical  music  may  be  less 
enjoyable  than  his  second  experience  of  the  same  kind  of 
music.  He  has,  in  the  meantime,  become  a  more  cultured 
person.  But  assuming  that  no  opportunity  for  develop- 
ment in  taste  is  permitted,  the  pleasure  derived  from  the 
first  hour  of  listening  to  good  music  will  be  greater  than 
that  derived  from  a  second  successive  hour  of  equally  good 
music.  The  utility  of  the  second  hour  of  music  is  less.  And 
so  we  may  accept  it  as  a  general  rule  that  the  utility  of  a 
unit  of  any  kind  of  good  diminishes  as  the  number  of  such 
units  in  one's  possession  increases. 

6.  TJie  want-satisfying poivei'-  of  the  least  impoi'tant  unit 
of  a  commodity  in  one's  possession  is  termed  tJte  final  or 
marginal  ntility  of  that  commodity. 

In  the  foregoing  examples  it  has  been  assumed  that  the 
quantity  of  the  goods  increased  until  no  desire  for  further 
units  existed.  Most  of  the  things  which  we  desire  are  not 
to  be  had  in  superfluous  quantities.  Instead  of  having 
five  units,  each  consisting  of  three  bushels  of  wheat,  let  us 
assume  that  I  have  but  three.  The  third  unit  would  still 
have  a  utility  of  lo^-.  As  this  is  the  utiHty  of  the  last  or 
final  or  marginal  part  of  my  supply,  it  is  called  final  or 


UTILITY,   VALUE,   AND    PRICE  27 

marginal  utility.  Suppose  that  I  have  only  ten  seashells, 
and  that  the  utility  of  the  tenth  is  5j'.  In  economic  lan- 
guage 5 J'  is  the  final  or  marginal  utility  of  seashells. 
Final  utility,  it  is  clear,  is  a  very  variable  quantity  ;  if  the 
desire  for  a  good  increases,  with  no  increase  in  the  num- 
ber of  units  of  the  good,  final  utility  increases  ;  if  the  de- 
sire remains  the  same,  but  the  number  of  units  of  the  good- 
diminishes,  final  utility  again  increases.  In  the  first  ex- 
ample, if  the  third  unit  of  wheat  were  destroyed,  the 
marginal  utility  of  wheat  would  at  once  become  100  .t-. 

Conversely,  marginal  utility  diminishes  with  decrease 
in  want  or  increase  in  number  of  units.  I  might  tire  of 
collecting  seashells,  or  the  waves  might  wash  up  a  wagon- 
load  of  them.  In  either  case  the  marginal  utility  would 
shrink  —  perhaps  to  zero. 

7.  ///  effect,  the  iinfortajice  of  any  unit  of  a  commodity  is 
determined*  by  the  zvant-satisfying  pozver  of  the  marginal 
unit.  The  importance  of  a  unit,  thus  determined,  is  termed 
its  effective  utility. 

But  does  any  man  really  arrange  his  wheat  or  other 
goods  in  series  of  units  and  say  to  himself :  "  This  unit  is 
worth  1000 .r;  without  it  I  should  starve;  this  unit  is 
worth  100 .r,  as  my  comfort  and  strength  depend  upon  it; 
this  unit  is  worth  5.1-,  for  if  I  did  not  have  it  I  should  be 
compelled  to  do  without  my  pets".''  Not  at  all;  the  dif- 
ferent units  are  just  alike,  and  one  is  thought  of  as  just  as 
desirable  as  another.  For  practical  purposes,  the  utility  of 
one  unit  is  the  same  as  that  of  another.  Let  us  suppose 
that  there  are  four  units  of  wheat,  and  that  the  last  has  a 
utility  of  5,f.  What  is  lost  if  any  one  of  the  four  units  is 
lost  '^  Simply  5  x.  What  sacrifice  would  one  make  to 
prevent  the  loss  of  any  unit,  even  the  one  which  would 
have  been  used  to  sustain  life,  and  by  itself  would  be 
worth  looo.r.''  A  sacrifice  not  greater  than  $x.  For  if 
any  other  unit  is  lost,  the  least  important  one  will  be  sub- 


28  INTRODUCTION   TO   ECONOMICS 

stituted  for  it,  and  the  effective  loss  will  be  properly  placed 
at  5^. 

The  utility  of  the  last  and  least  important  unit,  then, 
exercises  an  important  influence  in  determining  what  util- 
ity one  will  in  effect  ascribe  to  any  unit..  For  practical 
purposes  the  utility  of  any  unit  is  exactly  equal  to  that  of 
the  least  important  one.  The  utility  of  a  unit,  thus  meas- 
ured by  that  of  the  least  important  one,  is  called  "  effective 
utilitv." 

If  the  total  number  of  units  of  a  good  is  so  great  that 
the  last  one  has  no  utility,  the  good  has  no  effective  utility 
at  all.  No  one  will  do  anything  to  prevent  the  destruction 
of  part  of  his  supply ;  no  one  will  give  anything  to  in- 
crease his  supply.  Thus  water,  although  a  single  gallon 
would  have  indefinitely  great  utility  if  this  were  the  only 
gallon  available,  is  in  most  places  so  abundant  that  the 
last  units  of  the  supply  have  no  utility.  Therefore  no 
unit  has  effective  utility. 

8.  A  knowledge  of  the  comparative  effective  utilities  of 
different  goods  is  essential  to  the  ratiojial  application  of 
means  for  the  production  or  acquisition  of  goods. 

Almost  every  one  who  is  about  to  engage  in  the  produc- 
tion of  wealth  has  several  options  as  to  the  kinds  of  goods 
he  may  produce  and  as  to  the  qualities  or  grades  of  each 
kind.  A  farmer  may  produce  wheat  or  corn,  cattle  or 
hogs ;  he  may  produce  a  hard  grade  of  wheat  or  a  soft 
one  ;  he  may  produce  thoroughbred  stock  or  grade  stock. 
Every  man  who  is  at  the  point  of  making  a  purchase  has 
numerous  options  as  to  the  goods  upon  which  he  is  to 
spend  his  money.  Some  options,  naturally,  offer  greater 
advantages  than  others. 

Suppose  that  a  cultivator  can  produce,  with  the  expen- 
diture of  one  day's  labor,  two  bushels  of  potatoes  or  one 
bushel  of  wheat.  Should  he  spend  his  time  in  producing 
wheat,  or  potatoes,  or  both  ?     If  the  effective  utility  of  two 


UTILITY,   VALUE,    AND    PRICE  29 

bushels  of  potatoes  is  greater  than  that  of  a  bushel  of 
wheat,  the  rational  thing  for  him  to  do  is  to  produce  more 
potatoes  and  to  spend  less  time  producing  wheat.  In  ac- 
cordance with  the  law  of  diminishing  utility,  the  effective 
utility  of  potatoes  will  decline  as  their  quantity  increases ; 
at  the  same  time,  that  of  wheat  will  increase,  as  our  ex- 
ample assumes  that  labor  formerly  occupied  in  wheat  pro- 
duction is  diverted  to  the  raising  of  potatoes.  A  point 
will  probably  be  reached  where  a  day's  labor  will  produce 
as  much  utility  in  one  branch  of  agriculture  as  in  the 
other ;  and  until  this  point  is  reached,  tlie  cultivator  has  it 
in  his  power  to  increase  his  welfare  simply  by  making  a 
more  rational  distribution  of  his  labor. 

But  before  one  can  rationally  distribute  his  labor  or 
other  resources,  he  must  have  a  definite  notion  of  the 
relative  effective  utilities  of  goods.  He  must  measure  the 
utility  of  one  —  the  degree  to  which  it  seems  desirable  to 
him  —  in  terms  of  the  utility  of  another ;  or  he  must 
measure  them  all  by  a  common  standard.  And  this,  of 
course,  is  easy  to  do.  Think  of  any  two  objects.  Which 
seems  the  more  desirable  ?  That  one  has  the  greater 
utility  for  you.  How  far  would  you  walk  in  order  to  get 
good  No.  I  .''  If  you  would  walk  twice  as  far  to  get  good 
No.  2,  the  latter  has,  for  you,  twice  the  effective  utility  of 
the  former.  Any  good,  or  any  sacrifice,  may  serve  thus 
as  a  standard  for  measuring  the  comparative  utilities  of 
goods.  Under  existing  economic  conditions,  of  course,  the 
standard  which  most  readily  occurs  to  one  is  money.  If 
one  wishes  to  compare  the  utilities  of  wheat  and  potatoes, 
he  naturally  considers  how  much  money  he  would  give  for 
a  bushel  of  either. 

9.  77/c  utility  of  a  good,  measured  by  some  standard, 
eitJier  of  ?itility  or  saerifice,  is  personal  value.  Personal 
value  varies  from  individual  to  individual,  arid  is  constantly 
fluctuating. 


3° 


INTRODUCTION   TO    ECONOMICS 


Now,  the  effective  utility  of  a  commodity,  compared  with 
that  of  some  other  commodity,  or  compared  with  some 
sacrifice  which  serves  as  a  standard,  is  personal  or  "  sub- 
jective "  value.  Value  in  this  sense  of  the  term  is  effective 
utility  measured.  And  as  effective  utility  is  constantly 
fluctuating  with  changes  in  the  amount  of  a  good,  or  in  the 
desire  for  it,  personal  value  is  also  always  fluctuating. 

We  often  hear  of  the  "  real"  value  of  a  thing,  or  of  the 
"intrinsic  "  value,  as  if  there  were  some  kind  of  value  resi- 
dent in  a  thing  apart  from  man's  desire  for  it.  Of  course, 
there  can  be  no  such  thing.  The  value  of  a  thing  to  any 
person  is  its  importance  at  a  givn  time  and  place. 

Values  will  naturally  be  different  for  different  persons. 
What  is  the  value  of  my  grandfather's  watch  .-'  To  me,  it 
may  be  equal  to  that  of  $1000.  Perhaps  you  would  not 
give  $10  for  such  an  antiquated  timepiece.  In  less  extreme 
degree  the  same  thing  holds  of  every  good.  Some  will 
place  a  high  value  upon  an  object ;  others  a. low  value  ;  and 
the  one  is  as  properly  the  true  or  intrinsic  value  as  the 
other. 

But  is  there  not  a  certain  scale  of  values  in  which  most 
persons  agree,  and  has  not  this  general  value  a  claim  to  the 
title  "  true  value  "  .-'  There  is  indeed  something  like  a  scale 
of  values  established,  as  it  were,  by  common  consent ;  and 
the  economic  activities  of  each  are,  as  it  were,  directed 
toward  making  his  own  scale  of  values  conform  to  that 
of  society.  How  this  social  scale  of  values  arises  out  of 
the  purely  personal  values  just  described,  it  will  be  our 
next  task  to  consider.  It  is  of  course  self-evident  that  the 
social  value  does  so  arise.  One  cannot  conceive  of  society 
as  establishing  values  and  imparting  them  to  individuals. 

10.  Personal  values  are  in  some  measure  socialized 
through  imitation. 

Utility,  as  we  have  seen,  is  a  quality  with  which  an  ob- 
ject is  endowed  by  virtue  of  a  human  want.     This  want 


UTILITY,    VALUE,    AND    PRICE  31 

may  arise  out  of  personal  or  out  of  social  need.  If  a  par- 
ticular social  need  should  disappear  or  change,  certain  of 
our  wants  would  disappear  or  change.  Certain  classes  of 
goods,  destined  to  satisfy  such  wants,  would  lose  their 
value,  or  undergo  some  change  in  it.  There  was  a  time 
when  gentlemen  clipped  their  own  hair  and  covered 
their  heads  with  wigs.  To  move  in  polite  society,  one  had 
to  follow  this,  as  other  fashions.  Hence  there  was  a  want 
for  wigs,  and  these  were  endowed  with  effective  utility  and 
value  accordingly.  As  the  wearing  of  one's  own  hair 
came  into  vogue,  this  particular  kind  of  wig  ceased  to 
have  either  utility  or  value.  Now  it  is  clear  enough  that 
the  great  majority  of  those  who  followed  the  earlier  fash- 
ion could  have  had  no  personal  need  nor  want  for  a  wig. 
They  derived  the  want  from  their  associates.  The  custom, 
I  suppose,  originated  with  some  bald-headed  prince,  who 
really  needed  a  wig.  And  so  it  was  transmitted  from  the 
court  to  the  gentry,  and  persisted  long  after  the  reason  for 
its  existence  had  disappeared.  The  value  of  wigs  thus 
arose  from  a  personal  need  ;  it  attained  vogue  through 
imitation,  and,  by  a  similar  process,  faded  out  and  disap- 
peared. 

Suppose  that  I  attend  an  auction  of  the  effects  of  an 
eccentric  gentleman,  who  has  led  a  solitary  life  collecting 
odds  and  ends  of  all  kinds,  among  them  some  things  of 
value.  I  find  a  painting  that  pleases  me.  Say  that  I 
know  nothing  of  art,  and  that  all  the  painting  represents 
to  me  is  a  group  of  dull,  brutish  persons,  making  unneces- 
sarily hard  work  out  of  some  simple  agricultural  operation. 
What  is  its  value  to  me  .-'  It  would  be  difficult  to  say  ; 
certainly  in  my  own  mind  the  value  is  something  very 
tentative,  l^ut  finding  that  the  picture  can  be  had  for  no 
great  sum,  I  resolve  to  buy  it.  I  hang  my  acquisition  in 
an  inconspicuous  place,  for  I  am  not  sure  whether  I  should 
be    proud   of  it  or  ashamed  of  it.     A  friend  who  knows 


12  INTRODUCTION   TO   ECONOMICS 

something  of  art  calls  on  me.  Perhaps  he  takes  merely  a 
glance  at  the  picture  and  says  nothing.  Its  value  to  me 
shrinks  to  zero.  But  if  he  cries  enthusiastically,  "Ah!  a 
Millet !  "  immediately  its  value  to  me  expands  in  an  ex- 
traordinary fashion;  what  had  been  scarcely  a  valuable 
object  at  all  becomes  a  priceless  treasure. 

Here  then  is  one  reason  why  values  for  different  per- 
sons tend  to  conform  to  the  same  scale.  If  I  iind  that 
most  of  my  friends  think  that  a  riding  horse  is  dear  at 
$300,  I  think  so,  too,  although  I  might  get  more  satis- 
faction out  of  the  horse  than  they.  Value  is  thus  in  large 
measure  a  matter  of  imitatioi"*.  But  before  one  can 
imitate,  there  must  be  something  original  to  serve  as  a 
center  of  imitation  ;  and  in  the  matter  of  values,  this  must 
be  the  original  personal  value  of  some,  arising  out  of 
effective  utility  to  them. 

Moreover,  though  imitation  brings  about  a  certain  uni- 
formity in  the  scales  of  values  of  different  persons,  it  can 
not  of  itself  make  them  absolutely  alike.  If  most  of  my 
friends  think  that  a  particular  horse  is  worth  $200,  I  cer- 
tainly would  not  value  it  at  $300,  unless  indeed  I  am  a 
connoisseur  in  horseflesh  and  my  friends  are  not.  But  I 
may  think  the  horse  is  cheap  at  $200,  while  my  friends 
may  think  it  is  dear.  And  this  shows  that  in  spite  of  all 
tendency  to  conform,  I  retain  a  scale  of  values  that  is 
peculiarly  my  own. 

11.  The  most  ejfective  force  making  for  socialization  of 
values  is  exchans'e. 

So  long  as  men  lived  in  self-sufficing  groups,  producing 
whatever  they  needed  for  their  own  use,  there  was  no 
other  force  than  imitation  which  could  make  the  personal 
valuations  of  one  group  correspond  with  those  of  another. 
But  in  an  exchange  economy  there  is  a  much  more  potent 
force  making  for  the  socialization  of  values. 

Suppose  that   two  farmers,  with  adjoining  fields,  both 


UTILITY,    VALUE,   AND    PRICE  ^^ 

grow  potatoes  and  wheat,  and  suppose  that  they  are  so 
far  from  a  market  that  they  can  exchange  their  products 
only  with  each  other.  Farmer  A  may  consider  that  a 
bushel  of  wheat  is  worth  two  bushels  of  potatoes  ;  Farmer 
B  may  consider  a  bushel  of  potatoes  worth  two  bushels  of 
wheat. 

Assuming  such  a  divergence  in  personal  valuations  the 
natural  result  will  be,  not  that  they  will  debate  the  relative 
justice  of  their  views  of  value,  but  that  they  will  trade. 
Farmer  A  can  afford  to  offer  Farmer  B  two  bushels  of 
potatoes  for  a  bushel  of  wheat ;  Farmer  B  can  afford  to 
accept  even  a  half  bushel  of  potatoes  for  a  bushel  of  wheat. 
Exactly  how  much  A  will  at  first  offer,  we  cannot  say, 
nor  is  that  of  much  importance.  What  is  certain  is  that 
he  can,  and  probably  will,  offer  terms  that  will  be  accept- 
able to  B,  and  some  bushels  will  be  exchanged. 

Now,  as  A  parts  with  some  of  his  potatoes,  the  effective 
utility,  and  with  it  the  value,  of  potatoes  to  him  increases. 
As  he  gets  more  wheat,  the  effective  utility  of  wheat  de- 
clines. And  the  reverse  will  be  the  case  with  B,  who  is 
increasing  his  stock  of  potatoes  and  diminishing  his  stock 
of  wheat.  It  may  still  be  worth  while  for  the  two  farmers 
to  exchange  more  bushels  ;  but  it  is  not  so  much  worth 
while  as  it  was  at  first.  In  the  end,  exchange  must  cease, 
for  each  will  value  wheat  in  terms  of  potatoes  exactly  as 
the  other  does. 

Perhaps  Farmer  A  has  land  that  is  very  well  adapted 
to  potato  production,  while  Farmer  B's  land  is  best  fitted 
for  the  growing  of  wheat.  In  another  year  A  will  have 
a  superfluity  of  potatoes  and  B  of  wheat,  and  the  process 
of  exchange  will  again  be  necessary  to  equalize  values. 
So  in  a  developed  economic  system  the  value  of  wheat  in 
regions  where  it  is  produced  tends  continually  to  fall  below 
the  value  of  it  in  regions  where  little  wheat  is  grown  ;  and 
this  it  is  that  keeps  up  a  constant  exchange  between  dis- 


34 


INTRODUCTION   TO   ECONOMICS 


tant  regions.  And  this  constant  exchange,  in  turn,  tends 
to  eliminate  the  discrepancies  in  vahies. 

Returning  to  the  case  of  the  two  neighbors,  perhaps  A 
has  a  cow  which  he  does  not  care  to  keep,  but  which  B 
would  like  to  have  ;  while  the  latter  has  a  harrow  which 
he  does  not  need,  but  the  former  could  well  use.  Possibly 
A  values  the  cow  at  twenty  bushels  of  wheat  and  the 
harrow  at  thirty  ;  while  B  values  the  cow  at  thirty  bushels 
of  wheat  and  the  harrow  at  twenty.  Here  is  a  good 
opportunity  for  a  trade.  Either  one  might  give  the  other 
a  certain  number  of  bushels  of  wheat  "to  boot,"  in  order 
to  bring  about  the  trade.  At  what  terms  will  the  exchange 
be  made .''  We  cannot  tell.  Nor  will  the  exchange,  at 
whatever  terms,  affect  the  relative  values  placed  upon 
cows  and  harrows  by  either  party  to  the  exchange.  It 
would  be  different  if  more  cows  and  harrows  were  to  be 
exchanged.  In  that  case  the  scales  of  values  of  the  two 
exchangers  would  tend  to  uniformity,  as  was  the  case  with 
the  potatoes  and  wheat.  But  very  likely  no  further  ex- 
changes are  to  be  made.  So  I  may  be  able  to  buy  for  $2$ 
2L  coat  that  I  would  regard  as  cheap  at  $50.  Another  coat 
at  $25,  however,  might  not  seem  worth  more  to  me  than 
$20;  accordingly,  I  refrain  from  buying  it.  Hence  the 
coat  which  I  do  buy  retains  a  personal  value  for  me  in 
excess  of  the  value  placed  upon  it  by  the  seller.  It  is  a 
value  that  as  a  whole  refuses  to  be  socialized.  A  similar 
state  of  affairs  exists  wherever  one  buys  single  goods,  not 
quantities  of  like  units,  as  in  the  case  of  wheat. 

12.  Personal  values  may  be  mere  rcJJcctions  from  social 
values.  Such  personal  values  may  be  called  personal  or  sub- 
jective exchange  values. 

In  the  examples  employed  in  the  last  section  it  was 
assumed  that  both  parties  to  the  exchange  had  personal 
values,  arising  out  of  their  own  wants,  for  both  commodities 
exchanged.     This  may  have  been   the  usual    case  under 


UTILITY,   VALUE,   AND    PRICE  35 

primitive  conditions ;  but  now,  when  we  produce  almost 
exclusively  for  sale,  the  seller  of  a  commodity  must  fix  a 
personal  value  in  some  other  way.  Say  that  I  am  a  dealer 
in  women's  shoes.  For  my  personal  use  they  have  no  value 
whatsoever.  Yet  when  a  prospective  customer  appears, 
I  have  just  as  definite  a  value,  below  which  I  would  not 
sell  the  shoes,  as  I  should  have  if  I  were  trading  off  a  pair 
of  shoes  that  I  might  use  myself.  Whence  do  I  derive 
this  value  .-*  I  know  that  if  I  do  not  sell  shoes  to  this  par- 
ticular buyer,  I  shall  probably  be  able  to  sell  them  to  some 
one  else.  And  I  will  take  no  less  for  them  than  I  think 
some  one  else  will  pay.  If  experience  shows  me  that  few 
persons  will  pay  the  price,  I  must  alter  my  personal  value, 
or  the  fashions  will  change,  and  I  shall  have  a  stock  of 
unsalable  leather  on  my  hands. 

Now  it  must  be  plain  that  this  kind  of  personal  value 
is  entirely  a  secondary  phenomenon.  It  is  derived  from 
the  estimate  of  other  men's  personal  values,  arising  from 
personal  needs.  It  has  its  importance ;  but  it  does  not 
explain  the  values  that  are  actually  placed  upon  goods. 
This  explanation  lies  in  the  facts  of  direct  personal 
valuation. 

13.  Value  expressed  in  terms  of  money  is  kiiozvn  in  eco- 
noniies  as  price. 

In  one's  personal  estimate  of  values  one  may  employ  as 
a  standard  of  measurement  any  object  having  effective 
utility.  The  farmer  may  value  a  horse  in  terms  of  wheat 
or  cotton ;  the  ranchman  in  terms  of  cattle  ;  the  fisherman 
in  terms  of  fish.  The  difficulty  with  such  estimates  is  that 
they  are  not  sufficiently  intelligible  to  other  persons.  A 
traveler  in  the  Orient  writes  that  a  certain  rajah  places 
the  value  of  an  elephant  at  2000  yards  of  Japanese  silk. 
Do  you  know  whether  the  elephant  is  dear  or  cheap .''  If 
the  valuation  were  made  in  terms  of  silver  or  gold,  we 
should  all  have  a  fairly  definite  idea  of  the  value  placed 


36  INTRODUCTION   TO   ECONOMICS 

upon  the  elephant,  as  we  are  constantly  using  these  metals 
and  estimating  their  importance.  In  practice,  then,  values 
are  usually  expressed  in  terms  of  silver  or  gold  money. 
For  convenience,  economists  use  the  the  term  "  price  "  as  the 
equivalent  of  money  value.  There  are  personal  prices  and 
social  prices,  just  as  there  are  personal  and  social  values. 
Social  prices  are  practically  determined  by  the  action  of 
buyers  and  sellers,  and  as  these  commonly  meet  in  a  mar- 
ket, social  price  is  called  market  price. 

14.  Maj'ket  prices  tcjid  to  a  iinifonnity,  and  correspond 
with  the  personal  prices  of  those  ivho  are  least  eager  to  buy  or 
to  sell,  but  ivlio  nevei'thcless  succeed  in  buying  or  selling. 

Personal  values,  as  we  have  seen,  naturally  vary  widely 
with  different  individuals.  We  need  not  believe  that  any 
two  persons  would  affix  exactly  the  same  money  valuation 
upon  a  particular  horse.  One  man  might  value  the  horse, 
for  his  personal  use,  at  $500;  another  at  $50.  Yet  we 
find  that  for  a  certain  grade  of  horses  there  is  something 
like  a  uniform  price.  Perhaps  this  price  is  $250.  In  such 
case  the  personal  values  of  $50  and  ^500  are  both  ignored. 
They  have  no  influence  upon  the  price  actually  set. 

Personally  I  may  abhor  the  idea  of  ballooning.  If  I 
were  to  place  a  value  upon  balloons  for  my  own  use,  it 
would  be  far  less  than  nothing.  Clearly  my  personal  value 
of  balloons  has  nothing  to  do  with  their  price,  which  for  a 
given  grade  may  be  $5000.  If  I  had  a  mild  interest  in 
this  form  of  sport  I  might  value  a  balloon  at  $1000;  yet  I 
should  not  influence  their  price.  Were  I  so  passionately 
fond  of  ballooning,  and  so  plentifully  provided  with  money, 
as  to  value  a  balloon  at  $100,000,  this  valuation  would 
nevertheless  be  incapable  of  raising  the  price  of  balloons 
much,  if  any,  above  $5000.  It  is  clear,  then,  that  some 
personal  values  count,  and  some  do  not,  in  the  determina- 
tion of  prices  as  they  are  fixed  in  the  market. 

To  show  just  what  it  is  that  determines  what  personal 


UTILITY,    VALUE,    AND    PRICE  37 

values  count  in  fixing  market  prices,  we  may  employ  a 
somewhat  artificial  example  which  is  the  common  property 
of  modern  text-books  in  economics.  Let  us  imagine  a 
horse  market  in  which  there  are  six  persons  with  horses  to 
sell,  and  six  persons  each  of  whom  would  like  to  buy  a 
horse.  We  will  assume  that  the  horses  are  as  alike  as 
peas,  so  that  each  buyer  would  as  willingly  have  one  as 
another.  Of  course  each  buyer  desires  to  buy  as  cheaply 
as  possible,  and  each  seller  desires  the  highest  possible  price 
for  his  horse.  Each  buyer  has  in  his  own  mind  a  top 
price  —  the  most  he  would  pay  under  any  circumstances  — 
and  each  seller  has  a  bottom  price,  below  which  he  would 
absolutely  refuse  to  go.  Being  rational  men,  the  buyers 
carefully  refrain  from  letting  their  top  prices  be  known  ; 
and  in  the  same  way  the  sellers  keep  their  lowest  prices  a 
close  secret.  We  shall  assume  the  fiction  writer's  omni- 
science, and  set  down  the  top  and  bottom  prices  of  the 
buyers  and  sellers  respectively,  as  follows  :  — 


Buyers 

Sellers 

A  $100 

M  $90 

B       90 

N     80 

C       80 

0     70 

D      70 

P     60 

E       60 

Q    50 

F       50 

R     40 

How  many  horses  will  be  sold,  and  at  what  price  ?  Of 
course,  if  each  of  the  buyers  in  the  first  column  were  shut 
up  in  a  stall  with  the  seller  in  the  opposite  column,  all  the 
horses  would  be  sold,  and  at  different  prices.  But  we 
are  assuming  that  all  are  in  an  open  yard,  and  hear  one 
another's  bids  and  offers.  Under  these  circumstances  no 
buyer  will  pay  more  than  another,  nor  will  one  seller  take 
less  for  his  horse  than  another.     What  price  will  actually 


38  INTRODUCTION    TO    ECONOMICS 

be  fixed  can  be  seen  by  following  out  in  detail  the  probable 
action  of  these  buyers  and  sellers. 

Suppose  A,  a  buyer,  offers  $40  as  his  first  bid.  R  could 
afford  to  take  it ;  but  as  any  of  the  other  five  buyers  would 
be  glad  to  get  a  horse  at  that  price,  they  each  offer  a  little 
more  than  $40.  Competition  for  this  horse  goes  on  until 
the  price  is  raised  to  $$0.  At  this  point  two  horses  may  be 
had  ;  but  there  are  six  competing  buyers,  and  the  price 
goes  higher.  Thereupon  F,  who  will  pay  no  more  than 
$50,  drops  out.  He  can  exercise  no  more  influence  in  de- 
termining the  price  of  these  horses  than  I  can  in  deter- 
mining the  price  of  balloons.  Bidding  goes  on,  and  the 
price  is  forced  up  to  $60.  Three  horses  are  to  be  had  at 
this  price ;  but  as  there  are  still  five  buyers  the  price  goes 
above  $60,  and  E  drops  out.  At  last  the  price  reaches  $70. 
There  are  now  four  sellers  willing  to  part  with  their  horses 
at  this  price;  and  four  buyers  willing  to  pay  the  price. 
Imagine  that  bidding  goes  on,  and  the  price  rises  to  $71. 
D  would  then  drop  out,  and  four  horses  would  be  offered, 
with  only  three  buyers.  Any  one  of  the  four  sellers  would 
rather  sell  at  $70  than  have  his  horse  unsold  ;  bidding 
among  the  sellers,  therefore,  forces  the  price  back  to  $70. 
Under  the  conditions  this  price  represents  an  equilibrium 
between  the  values  of  the  buyers  and  those  of  the  sellers. 

Let  us  imagine,  however,  that  before  the  sale  is  actually 
effected,  another  buyer,  with  a  maximum  valuation  of  $110, 
appears.  The  price  will  then  be  forced  above  $yo,  and  D 
will  drop  out.  It  will  not  reach  $80,  however,  for  then  five 
sellers  would  compete  to  meet  the  needs  of  four  buyers. 
The  actual  price  will  be  fixed  somewhere  between  $70  and 
$80.  If  an  additional  seller,  with  a  valuation  of  $30,  were 
to  'appear,  the  number  of  buyers  remaining  the  same,  the 
price  would  drop  below  $70,  but  not  quite  to  $60. 

The  seller  who  is  least  desirous  of  selHng,  but  who  never- 
theless effects  a  sale,  is  known  as  the  marginal  seller.     The 


UTILITY,    VALUi:,   AND    PRICE  39 

buyer  who  is  least  eager  to  buy,  but  yet  succeeds  in  buying, 
is  known  as  the  marginal  buyer. 

15.  Demand  is  tJie  volume  of  purchases  of  a  commodity 
that  tvonld  be  niadc  at  a  given  priee.  Supply  is  the  volume 
of  sales  that  would  be  made  at  a  given  price.  Market  price 
is  fixed  at  a  point  ivhich  tends  to  equalize  demand  and 
supply. 

Every  person  who  reads  widely  in  economic  literature, 
frequently  encounters  the  statement  that  market  prices 
are  determined  by  demand  and  supply.  It  is  therefore 
worth  while  to  ascertain  exactly  what  these  terms  mean. 
Demand  is  clearly  not  synonymous  with  want  or  desire. 
We  may  imagine  a  Hindoo  grain  dealer  closing  up  his 
shop  because  there  is  no  demand  for  grain,  although  he 
may  be  besieged  by  an  army  of  starving  people.  Desire 
must  be  supported  by  purchasing  power  before  it  becomes 
demand.  Supply  does  not  mean  the  existing  stock  of  a 
commodity.  There  may  be  a  shortage  in  the  wheat  supply 
because  those  who  have  wheat  arc  holding  it  for  higher 
prices.  The  owner  of  a  commodity  must  be  willing  to  sell 
before  the  stock  in  his  possession  becomes  part  of  the 
supply.  It  is  evident  that  in  most  instances  the  lower  the 
price  of  a  commodity,  the  greater  will  be  the  demand  for 
it  and  the  less  will  be  the  supply,  and  vice  versa.  The  de- 
mand for  wheat  at  ten  cents  a  bushel  would  be  enormous, 
the  supply  at  that  price  would  dwindle  to  practically  noth- 
ing. There  must  be  some  price  for  each  commodity  that 
will  exactly  equalize  the  volume  of  demand  with  that  of 
supply.  This  price  is  the  one  that  will  prevail  in  the 
market. 

At  a  given  time  the  aggregate  demand  for  wheat  at  $2 
a  bushel  may  extend  to  one  million  bushels  ;  but  the  sellers 
of  wheat  may  be  willing  to  j)]ace  on  the  market  two  million 
bushels  at  that  price.  Manifestly  $2  a  bushel  cannot  be 
the  price  .set  by  the  market,  for  the  owners  of  the  second 


40  INTRODUCTION   TO   ECONOMICS 

million  bushels,  not  finding  purchasers,  will  offer  it  for  less. 
At  a  lower  price,  some  sellers  will  drop  out,  and  some  ad- 
ditional purchasers  will  appear.  At  $1.50  a  bushel,  per- 
haps fifteen  hundred  thousand  bushels  will  be  offered,  and 
the  same  amount  taken.  Then  ^1.50  is  the  price  that  will 
actually  be  set. 

Those  buyers  whose  personal  valuations  are  the  lowest, 
and  who  would  be  ready  to  drop  out  if  the  price  rose,  are  the 
ones  who  at  any  particular  time  determine  the  volume  ot 
the  demand.  Those  sellers  whose  personal  values  are 
highest,  and  who  are  ready  to  drop  out  if  the  price  falls, 
determine,  for  the  time  being,  the  volume  of  the  supply. 
The  principle  that  the  price  is  fixed  at  a  point  which  equal- 
izes demand  and  supply  is  therefore  tantamount  to  the 
principle,  given  in  section  14,  that  price  corresponds  with 
the  personal  valuations  of  those  who  are  least  eager  to  buy 
or  to  sell,  or  the  marginal  buyers  or  sellers. 

16.  A  partic7ila7'  set  of  marginal  buyers  and  seller's  con- 
trol prices  only  for  a  brief  time. 

While  it  is  the  buyers  and  sellers  who  are  just  ready  to 
drop  out  with  changes  in  price  —  the  marginal  buyers  and 
sellers  —  who  at  a  given  time  hold  the  price  where  it  is, 
price  changes  may  take  place  in  spite  of  them,  through 
changes  in  the  wants  of  purchasers,  or  through  the  ap- 
pearance of  new  sellers.  The  introduction  of  the  automo- 
bile resulted  in  a  new  demand  for  gasolene,  and  as  a 
consequence  the  price  rose,  eliminating  the  purchasers  who 
had  before  been  in  a  price-determining  position.  If  alcohol 
should  be  successfully  substituted  for  gasolene  for  the  same 
purpose,  the  price  of  gasolene  would  fall,  and  a  new  set  of 
purchasers,  who  formerly  had  nothing  to  do  with  fixing  its 
price,  as  they  did  not  desire  it  enough  to  buy  it,  would 
come  to  occupy  the  position  of  controllers  of  the  price. 

Under  existing  conditions  we  do  not  find  ourselves  in 
the  presence  of  unpriced  goods  upon  which  a  price  is  to 


UTILITY,   VALUE,    AND    PRICE  41 

be  placed.  Everything  that  one  wishes  to  buy  already 
bears  a  price  ;  one  accepts  the  price,  or  refrains  from  pur- 
chasing. I  compare  my  personal  value  of  anything  —  say 
a  hat  —  with  the  value  of  the  commodity  in  the  market. 
If  I  decide  that  a  hat  is  worth  more  than  $5  to  me,  I  pur- 
chase it  if  it  is  to  be  had  at  that  price.  As  I  part  with  some 
of  my  money,  each  dollar  I  have  is  worth  more  to  me ;  and 
hats  are  worth  less.  Thus  I  make  my  personal  value  ap- 
proximate that  of  the  market.  If  I  am  a  seller  of  hats, 
and  I  find  that  $5  are  worth  more  to  me  than  a  hat,  I 
willingly  part  with  the  hat  at  that  price.  As  I  have 
more  dollars,  one  is  worth  less  to  me ;  having  fewer 
hats,  I  am  not  so  eager  to  part  with  one.  Thus  by  buy- 
ing and  selling  one  makes  his  personal  values  conform 
more  nearly  to  that  of  the  market.  At  the  same  time,  by 
taking  a  hat  from  the  seller,  I  reduce  by  a  trifle  the  num- 
ber to  be  sold  to  other  purchasers  ;  I  make  the  hat  sellers 
less  eager  to  sell,  and  contribute  of  my  puny  strength  to 
draw  up  the  general  level  of  value  of  hats  to  my  own 
personal  value.  So  all  of  us  who  are  purchasers  are 
joining  our  efforts  to  raise  prices  to  a  high  level,  although 
what  we  desire  is  low  prices  ;  and  all  of  us  who  are  sellers 
are  exerting  our  combined  strength  to  pull  them  down, 
although  we  are  anxious  to  have  high  prices.  Those  of 
us  who  are  least  eager  to  buy  or  to  sell  exercise  an  equal- 
izing function  ;  when  the  buyers'  side  prevails,  and  prices 
are  rising,  the  least  willing  buyers  drop  out;  and  similarly 
with  the  least  willing  sellers,  when  the  sellers  succeed  in 
pulling  prices  down. 

17.    Smin/Kiiiy. 

Progress  in  civilization  is  attended  by  an  ever  increasing 
number  of  wants.  Of  these,  some  are  inelastic  :  though 
often  very  insistent,  they  can  easily  be  completely  satisfied. 
Other  wants  are  elastic.  Complete  satisfaction  of  elastic 
wants    is    difficult.     Wants  of  the  latter  class  evince  the 


42  INTRODUCTION   TO   ECONOMICS 

greater  tendency  toward  development  with  the  progress  of 
civiHzation.  Wants  of  both  classes  admit  of  different  de- 
grees of  satisfaction ;  in  the  case  of  every  want  successive 
increments  in  the  means  of  satisfaction  are  desired  with 
diminishing  intensity. 

Utility  is  want-satisfying  power.  Successive  increments 
of  any  good  diminish  in  utility  as  the  want  endowing  them 
with  utility  diminishes  in  intensity.  The  least  important 
of  a  number  of  units  of  a  given  good  is  known  as  the  mar- 
ginal unit ;  its  utility  is  termed  marginal  or  final  utility. 
In  effect,  the  utility  of  any  unit  of  a  given  good  is  no 
greater  than  that  of  the  marginal  unit.  The  utility  of  any 
unit,  thus  reduced  to  terms  of  that  of  the  marginal  unit,  is 
effective  utility. 

In  order  that  a  man  may  direct  his  economic  activities 
to  the  best  advantage,  he  must  often  compare  the  effective 
utility  of  one  commodity  or  service  with  that  of  another. 
The  effective  utility  of  one  good  thus  measured  by  that  of 
another  is  personal  value.  Personal  values  vary  from  in- 
dividual to  individual ;  they  may,  however,  be  reduced  to 
approximate  uniformity  through  imitation  or  through  ex- 
change. When  all  the  personal  values  in  a  social  group 
have  been  reduced  to  uniformity,  social  values  emerge. 
These  values,  expressed  in  terms  of  money,  are  prices. 

In  a  market  prices  are  fixed  at  a  level  corresponding 
with  the  personal  valuations  of  those  actual  buyers  who 
are  least  eager  to  buy  and  those  sellers  who  are  least  eager 
to  sell.  From  another  viewpoint,  it  will  be  seen  that 
prices  are  established  when  the  amount  offered  for  sale 
just  equals  the  amount  sought  by  purchasers,  or,  in  other 
words,  where  demand  and  supply  are  equal. 


CHAPTER    III 

NORMAL    COMPETITIVE    PRICE 

1.  TJic  market  price  of  the  most  important  commodities 
is  subject  to  frequent  flnctuatio7is. 

Since  prices  depend  upon  the  valuations  of  the  mar- 
ginal buyers  and  sellers,  or,  what  amounts  to  the  same 
thing,  upon  demand  and  supply  —  factors  that  are  con- 
stantly changing  —  we  should  naturally  expect  prices  to 
fluctuate.  That  they  do  fluctuate  is  easily  proved,  either 
by  our  daily  experience  in  buying  and  selling,  or  by  an 
examination  of  price  statistics.  In  the  period  from  May, 
1907,  to  December,  1908,  the  price  of  wheat  in  New  York 
ranged  from  $o.8i|  per  bushel  to  $i.i4|.  The  price  of 
corn  ranged  from  57  cents  per  bushel  to  90  cents;  the 
price  of  cotton,  from  "^W  cents  per  pound  to  \^\  cents; 
the  price  of  wool,  from  20  cents  to  28  cents ;  the  price  of 
copper,  from  12.37.]  cents  to  25.50  cents. 

We  are,  indeed,  familiar  with  a  large  class  of  commodi- 
ties the  price  of  which  never  varies.  Postage  stamps 
are  always  sold  at  uniform  prices.  Many  patented  arti- 
cles, especially  goods  for  personal  use,  and  most  copy- 
righted books,  are  sold  at  unvarying  prices.  From  May, 
1907,  to  December,  1908,  steel  rails  were  quoted  at  $28 
per  ton  —  never  more,  never  less.  The  explanation  of* 
such  steadiness  in  price  is  always  the  same  —  monopoly, 
in  one  "form  or  another.  Where  there  is  but  one  seller, 
and  that  seller  resolutely  refuses  to  change  his  prices, 
there  can,  of  course,  be  no  price  fluctuations.  We  shall 
postpone  discussion  of  monopoly  prices  to  the  following 
chapter ;  in  the  present  we  are  concerned  with  the  laws 
governing  prices  in  the  competitive  field. 

43 


44  INTRODUCTION   TO   ECONOMICS 

2.  The  prices  of  perishable  commodities  fluctuate  mori 
widely  than  do  the  prices  of  those  commodities  that  art 
relatively  imperishable. 

In  the  cases  cited  in  the  foregoing  section  the  most 
marked  fluctuation  was  in  copper  —  a  little  over  loo  per 
cent.  But  for  the  fact  that  the  period  under  consideration 
began  with  an  artificially  high  price  of  copper,  owing  to 
speculative  manipulation  of  the  market,  and  ended  with 
an  artificially  low  price,  owing  to  the  same  cause,  the  price 
of  copper  would  probably  have  ranged  from  15  to  20 
cents.  Such  a  degree  of  fluctuation  in  a  staple,  non-per- 
ishable commodity  is  about  as  great  as  one  can  expect, 
even  in  a  much  longer  period  of  time.  If  the  price  of 
such  a  commodity  declines  perceptibly,  buyers  lay  in 
stocks,  in  expectation  of  a  reaction  toward  higher  prices, 
and  by  this  very  means  tend  to  bring  on  the  anticipated 
reaction.  The  prices  of  such  commodities  as  strawberries, 
fresh  vegetables,  and  fresh  fish  may  easily  advance  or  de- 
cline 100  per  cent  iti  a  single  week.  With  progress  in 
methods  of  preserving  such  commodities,  the  range  of 
price  fluctuations  is  .reduced.  We  do  not  buy  perishable 
commodities  at  such  low  prices,  nor  at  such  high  prices, 
as  were  known  before  refrigeration  came  into  common  use. 

3.  The  range  of  price  fluctuations  grozvs  less  ivith  im- 
provements in  transportation  and  the  extension  of  the 
7narket. 

In  the  early  part  of  the  nineteenth  century  England, 
through  the  policy  of  levying  heavy  duties  on  imported 
wheat,  forced  her  population  to  rely  almost  exclusively  upon 
the  domestic  supplies  of  grain.  As  a  consequence  of  this 
policy  a  good  season  meant  very  low  prices,  a  bad  season 
very  high  ones.  In  18 12  the  price  of  wheat  rose  to  $3.84 
per  bushel;  in  1822  the  price  was  $1.35.  To-day  such  a 
range  of  wheat  prices  is  unknown  in  England.  Wheat  is 
imported  from  all  quarters  of  the  globe,  and  it  is  impos- 


NORMAL    COMPETITIVE    PRICE  45 

sible  that  all  the  world  should  have  a  bad  season  at  one 
time.  If  the  American  crop  is  short,  it  is  highly  probable 
that  the  crop  in  Russia,  India,  or  Argentina  will  be  excep- 
tionally  heavy. 

Improvements  in  railway  transportation  have  made  pos- 
sible the  carriage  of  perishable  commodities  over  great 
distances.  Fresh  fish  from  the  Columbia  river  on  our 
northwest  coast  are  now  carried  to  Germany  when  the 
prices  in  the  German  market  are  high  enough  to  justify 
the  expense  of  transportation.  This  keeps  the  local  price 
of  fish  from  falling  so  low  as  it  otherwise  would,  when  the 
catch  is  heavy,  and  keeps  the  German  price  from  rising 
so  high  as  it  otherwise  would  when  the  Norwegian  fisheries 
yield  a  short  supply. 

We  are  safe  in  saying  that  modern  improvements  in 
transportation  and  market  organization  tend  to  eliminate 
sharp  fluctuations,  limited  to  a  small  area,  and  to  substi- 
tute more  moderate  fluctuations,  extending  over  wide 
areas. 

4.  Competitive  prices  tend  tcnvard  a  theoretical  level 
which  may  be  called  the  normal,  since  every  deviation  from 
this  level  is  followed  by  a  reaction. 

At  times  market  prices  rest  at  a  level  that  every  one 
knows  is  too  high  or  too  low  to  be  maintained  for  any  long 
period.  Such  prices  we  naturally  regard  as  abnormal. 
A  certain  fabric  comes  into  vogue;  everybody  must  have 
it,  and  as  there  is  not  an  indefinite  amount  of  it,  the  price 
rises.  Perhaps  it  was  worth  $1  a  yard  before  fashion 
touched  it  with  its  magic  wand  ;  the  price  may  easily  be- 
come $5.  Now,  is  this  price  one  that  is  likely  to  continue 
—  even  supposing  that  the  fashion  should  be  transformed 
into  a  custom,  and  the  enlarged  demand  for  the  fabric 
should  thus  become  permanent .''  Would  it  be  safe  for 
one  to  buy  large  stocks  of  this  cloth,  with  the  expectation 
of  selling  them  at  $5  a  yard .-'     Would  it  be  wise  for  one 


46  INTRODUCTION   TO   ECONOMICS 

to  put  up  a  mill  for  the  manufacture  of  this  kind  of  goods, 
with  the  expectation  that  the  high  price  would  continue? 
There  are  conceivable  conditions  under  which  one  might 
prudently  do  these  things ;  but  in  most  cases  this  would 
be  very  bad  business.  Most  probably,  the  price  would 
sink  again  toward  the  $i  mark.  In  all  likelihood  ^i  is 
about  what  that  fabric  will  sell  for  in  the  long  run. 

If  for  any  reason  the  price  of  wheat  rises  to  $2  a 
bushel,  we  can  predict  with  absolute  certainty  that  the 
number  of  sellers  will  go  on  increasing  until  the  price 
comes  down ;  $2  for  wheat  is  therefore  an  abnormal,  or 
unnatural,  price.  On  the  other  hand,  if  the  price  falls  to 
fifty  cents  a  bushel,  we  may  be  certain  that  in  time  sellers 
will  drop  out,  and  the  price  will  rise.  Fifty  cents  is  an 
abnormal  price,  just  as  $2  is.  Between  the  two  prices 
must  somewhere  be  one  that  is  normal  or  natural.  The 
market  price  will  be  constantly  rising  above  or  falling 
below  it ;  yet  there  will  always  be  an  increase  in  selling 
when  the  price  is  above  the  normal,  and  a  diminution  in 
the  number  of  sales  when  the  price  is  below  the  normal ; 
consequently  the  price  will  fluctuate  about  this  point, 
never  remaining  long  much  above  or  much  below  it. 

So  it  is  with  a  large  proportion  of  the  commodities  sold 
on  the  market.  Their  prices  may  at  any  time  double ; 
but  in  all  probability  this  is  a  transient  phenomenon.  If 
anything  is  sold  at  an  extremely  low  price  —  a  price  that 
has  rarely  been  known  before  —  probably  this  also  is  a 
transient  phenomenon.  And  just  as  it  would  be  bad 
business  to  buy  large  stocks,  or  build  factories,  in  anticipa- 
tion of  the  continuance  of  excessively  high  prices,  so  it 
would  be  folly  to  quit  a  business,  or  sell  out  all  one's 
stock,  because  of  excessively  low  prices.  The  business 
man  who  is  most  likely  to  succeed  is  the  one  who  has  a 
due  appreciation  of  normal  price  and  who  directs  his  busi- 
ness,  so  far  as  it  is  concerned  with  a  more  or  less  distant 


NORMAL    COMPETITIVK    PRICE  47 

future,  in  accordance  with  its  laws.  Normal  price,  there- 
fore, is  a  phenomenon  of  the  greatest  practical  importance. 
And  in  so  far  as  it  determines  the  direction  of  the  i)roduc- 
tive  forces  of  society,  it  is  of  the  highest  importance  to  the 
student  of  economics,  as  well  as  to  the  man  of  affairs. 
This  is  true  even  though  actual  prices  may  at  any  given 
time  be  above  or  below  the  normal,  and  may  perhaps 
never  remain  for  an  appreciable  time  at  precisely  the 
normal  level. 

5.  TJie  forces  w/iic/i  cause  prices  to  Jinver  about  a  normal 
level  origi}iate  in  tJie  field  of  production  or  supply. 

Prices,  we  have  seen,  rise  or  fall  in  consequence  of 
changes  either  in  demand  or  in  supply.  The  most  violent 
fluctuations  in  price  are,  as  a  rule,  due  to  changes  in  de- 
mand. Consider  the  fall  in  price,  in  the  early  autumn,  of 
summer  clothing.  Increase  in  supply  has  nothing  to  do 
with  this  price  change ;  decrease  in  demand  is  the  sole 
explanation.  Compare  the  price  of  a  striking  style  of 
women's  hats,  at  the  height  of  their  popularity,  with  their 
price  when  another  style  of  hat  gains  the  ascendency.  The 
forces  of  demand  originate,  in  large  part,  in  caprice,  indi- 
vidual and  social.  Were  prices  determined  solely  by  these 
forces  it  would  be  vain  to  search  for  a  law  of  normal  price. 

The  forces  governing  supply,  on  the  other  hand,  admit 
of  a  reasonable  degree  of  calculation.  Supply  is  controlled, 
in  a  measure,  by  chance,  as  in  the  case  of  the  products  of 
the  soil,  which  may  be  abundant  or  scarce  according  to 
the  season.  Far  more  important,  in  the  control  of  supply, 
are  the  decisions  of  producers,  and  these  decisions  are 
usually  the  result  of  calculations,  not  caprice.  A  man 
raises  hogs  or  peas  or  even  roses,  not  because  it  pleases 
him  to  do  so,  but  because  he  thinks  it  "  pays." 

The  supply  of  most  commodities  may  be  increased  or 
diminished  at  the  will  of  the  producers.  Many  producers 
are  in  a  position  to  increase  their  output  by  slightly  enlarg- 


48  INTRODUCTION   TO   ECONOMICS 

ing  their  working  force,  or  by  running  overtime.  Some 
producers  are  engaged  in  the  manufacture  of  a  number  of 
different  commodities,  or  of  grades  of  one  kind  of  com- 
modity. By  discontinuing  the  production  of  some  of  these 
and  concentrating  their  energies  on  a  single  one,  they  exert 
an  influence  upon  supply.  Moreover,  there  are  always 
some  persons  who  are  in  doubt  whether  or  not  they  shall 
enter  upon  a  certain  line  of  production ;  still  others,  now 
engaged  in  that  line  of  production,  are  in  doubt  whether 
or  not  they  shall  go  out  of  business. 

When  the  price  of  a  given  commodity  is  very  high,  fac- 
tories producing  that  commodity  run  on  full  time,  or  over- 
time ;  factories  that  would  otherwise  have  produced  several 
other  commodities  turn  all  their  energies  in  this  direction  ; 
manufacturers  who  were  in  doubt  as  to  whether  or  not 
they  should  go  on  producing,  find  their  doubt  stilled;  and 
new  producers  are  lured  into  the  industry.  All  this 
makes  for  an  increased  supply  and  a  falling  price.  How 
long  will  the  expansion  of  business  continue  .'* 

6.  Normal  price  is  that  price  wJiich  just  covers  the  cost  of 
production. 

The  two  factors  determining  the  business  conduct  of  a 
producer  are  price  and  cost  of  production.  In  the  cost  of 
production  are  included  the  value  of  materials  used  and 
the  wear  and  tear  and  general  depreciation  of  machinery, 
buildings,  lands  ;  interest  on  all  capital  used,  whether  bor- 
rowed or  owned  by  the  producer ;  wages  of  all  labor, 
whether  hired  or  that  of  the  producer  himself ;  premiums 
to  insurance  companies  for  the  assumption  of  the  risk  of 
destruction  of  buildings  and  stock,  or  an  equivalent  return 
for  risk  if  borne  by  the  producer  himself  ;  taxes,  water  rates, 
etc.  If  the  price  of  a  commodity  exceeds  its  cost,  includ- 
ing in  the  term  all  the  above-named  elements,  the  supply 
of  the  commodity  can  be  profitably  increased.  If  the  price 
just  equals  cost,  there  is  no  sufficient  reason  for  either  in- 


NORMAL   COMPETITIVE   PRICE  49 

creasing  or  diminishing  the  supply.     If  the  price  is  less 
than  cost,  the  supply  will  diminish. 

Suppose  that  it  costs  an  average  manufacturer  ^i  to 
produce  a  yard  of  woolen  cloth.  If  he  can  sell  it  for  $1, 
he  will  probably  go  on  producing  about  as  much  this  month 
as  he  did  last.  For  this  price  enables  him  to  pay  his  oper- 
atives, to  pay  interest  on  capital  borrowed,  to  pay  taxes 
and  insurance  premiums,  etc.  It  also  affords  him  as  much 
of  a  reward  for  his  labor  of  management  as  he  could  get 
if  he  placed  his  services  at  another  manufacturer's  dis- 
posal; and  as  large  a  return  on  his  own  capital  as  he  could 
get  from  any  other  equally  safe  investment.  But  suppose 
the  price  rises  to  $1.10.  For  every  yard  he  can  sell  he 
gets  ten  cents  over  and  above  all  costs.  This  amount  we 
shall  call  a  net  profit.  Of  course  he  desires  to  sell  as  many 
yards  as  possible.  He  works  his  mill  to  its  fullest  capacity; 
if  he  has  looms  that  are  nearly  worn  out,  he  makes  haste 
to  replace  them  with  m,ore  efficient  machinery  ;  if  he  has 
been  contemplating  the  erection  of  an  annex  to  his  mill, 
he  pushes  the  work  forward  as  rapidly  as  he  can.  Every 
other  manufacturer  in  his  line  does  the  same,  and  in 
time  the  increased  supply  of  the  fabric  forces  the  price 
down,  until  it  reaches  $1,  where  the  manufacturer  no 
longer  has  any  reason  for  increasing  operations.  Possibly 
the  price  goes  still  lower  and  reaches  ninety  cents.  This 
does  not  pay  all  costs,  but  the  manufacturer  may  still  con- 
tinue to  produce,  as  it  may  be  better  for  him  to  pocket  his 
loss  than  to  let  the  mill  stand  idle.  But  it  is  plain  that  he 
will  curtail  operations  wherever  he  can.  He  will  discharge 
his  least  efficient  workmen,  and  discontinue  the  use  of  his 
least  efficient  machines.  Every  other  manufacturer,  in 
greater  or  less  degree,  will  do  likewise.  So  the  supply 
falls  away  and  the  price  rises  toward  $i.  This,  then, 
is  the  normal  price  —  a  price  that  just  covers  cost  of 
production. 


5° 


INTRODUCTION   TO   ECONOMICS 


7.  While  it  may  be  to  the  interest  of  the  producers  of  a 
commodity ^  as  a  body,  to  limit  production  and  so  maintain 
prices  at  a  high  level,  it  is  to  the  interest  of  each  individiial 
producer  to  extend  his  oivn  production. 

If,  then,  the  price  of  a  commodity  exceeds  cost,  forces 
are  set  in  motion  which  tend  to  bring  the  price  back  to  the 
cost  level.  Now,  no  producer  wishes  to  sell  at  cost;  every 
producer  desires  an  excess  of  price  above  cost,  and  the 
greater  the  excess,  the  better  he  likes  it.  If  a  manufac- 
turer can  produce  a  certain  fabric  at  a  total  cost  of  $i,  and 
can  sell  it  at  ^i.io,  he  enjoys  a  very  comfortable  net  profit ; 
and  the  same  thing  is  true  of  all  other  manufacturers  in  the 
same  line,  and  they  might  continue  to  secure  this  net 
profit  if  each  one  would  refrain  from  enlarging  his  out- 
put. There  is,  then,  something  illogical  in  the  conduct  of 
the  several  producers,  viewed  in  a  certain  way.  Each  of. 
them  is  anxious  to  get  as  large  a  sum  of  net  profit  as  pos- 
sible ;  but  the  result  of  their  action  is  that  nobody  long 
continues  to  get  any  net  profit  at  all. 

The  reason  for  this  is  that  there  are  too  many  of  them 
for  any  one  to  have  a  perceptible  influence  on  price.  Sup- 
pose our  manufacturer  increases  his  output  lOO  per  cent. 
Probably  this  would  not  reduce  the  price  one  fiftieth  of  a 
cent  a  yard.  Therefore  he  obtains  nearly  twice  as  large 
a  sum  of  net  profit  as  he  would  have  done  if  he  had  kept 
his  output  unchanged  i)i  volume.  The  temptation  to  in- 
crease his  output,  then,  is  very  strong;  it  is  strengthened 
by  the  fact  that  he  knows  that  every  one  of  the  other  thou- 
sand producers  is  subject  to  the  same  temptation ;  some 
will  yield  to  it,  then  others,  finally  all;  and  those  who 
yield  first  will  be  the  ones  who  will  get  the  greatest  sum 
of  profit.  Under  the  conditions,  the  best  thing  for  the 
manufacturer  to  do  is  to  yield  to  the  temptation  the 
moment  it  offers. 

And  this  is  what  must  inevitably  occur  where  competi- 


NORMAL    COMPETITIVE    PRICE  51 

tion  exists  —  where  each  producer  may  increase  his  output 
if  he  desires  to  do  so.  However  mucli  it  may  be  against 
the  interests  of  all  the  members  of  a  group  of  producers  tu 
increase  operations,  it  is  to  the  interest  of  each  one  to 
increase  his  own  operations,  if  the  i)rice  of  his  products 
exceeds  their  total  cost. 

Often,  in  American  history,  have  different  classes  of 
producers  planned  a  universal  curtailment  of  production,  in 
order  to  force  prices  above  cost  level  and  hold  them  there. 
At  one  time  the  producers  of  raw  petroleum,  at  another  time 
the  producers  of  wheat,  at  still  another  time  the  producers 
of  cotton,  have  beguiled  themselves  with  such  plans.  If 
each  cotton  producer  would  plant  ten  per  cent  less  ground 
next  year,  the  price  of  cotton  would  probably  rise  twenty 
per  cent,  and  every  producer  would  get  more  money  for 
less  labor.  Suppose  that  the  cotton  producers  make  a  gen- 
eral agreement  to  this  effect.  Well,  every  producer  who- 
violates  his  agreement,  and  doubles  his  acreage,  will  get 
the  benefit  of  the  high  price,  and  the  additional  benefit  from 
an  unusually  large  quantity  to  sell.  Each  producer,  having 
his  own  interest  at  heart,  and  suspecting  the  integrity  of 
the  motives  of  others,  is  under  the  strongest  temptation  to 
increase  his  output.  Some  will  refrain  from  doing  so  ;  but 
enough  will  increase  their  acreage  to  keep  cotton  very  near 
to  cost  price. 

But  let  us  suppose  that  the  cotton  producers  are  able  to 
bind  themselves  legally  to  diminish  production,  ten,  twenty, 
fifty  per  cent,  or  that  some  Croesus  buys  up  all  the  cotton 
lands  and  fixes  production  at  the  figure  which  seems  most 
profitable  to  him.  In  either  case,  prices  will  cease  to  hover 
about  cost  of  production.  They  will  be  such  as  always  to 
afford  a  net  profit.  Such  prices,  in  contrast  with  normal 
or  competitive  prices,  are  called  monopoly  prices.  They 
are  controlled  by  laws,  but  these  laws  are  quite  different 
from  those  which  prevail  in  competitive  industry. 


52  INTRODUCTION   TO    ECONOMICS 

8.  Deviations  from  tlic  noruial  level  of  prices  are  quickly 
or  slowly  corrected  according  to  the  ease  or  difficulty  with 
wJiicJi  expansion  and  contraction  of  prodtiction  take  place. 

If  one  out  of  a  number  of  grades  of  ordinary  cotton  cloth 
rises  to  an  abnormally  high  price,  the  supply  of  that  grade 
of  cloth  increases  almost  immediately.  The  labor  and  ma- 
chinery that  have  been  employed  in  producing  other  grades 
are  diverted  to  the  production  of  the  grade  that  is  in  de- 
mand. A  few  weeks  or  months  probably  suffice  to  bring 
the  price  back  to  the  normal  level.  If  the  price  of  all  grades 
of  cotton  cloth  rises  above  the  normal,  a  longer  period  of 
readjustment  is  necessary.  New  factories  must  be  built  ; 
new  workers  trained  for  the  industry.  If  the  industry  has 
been  long  established,  indeed,  expansion  can  take  place  in 
less  time  than  would  be  required  if  the  industry  were  newly 
established.  Let  us  say  that  there  are,  in  a  long  established 
industry,  looo  mills  producing  the  same  grade  of  goods 
and  selling  them  in  a  common  market  at  a  uniform  price. 
Fifty  of  these  mills  become  so  dilapidated  each  year, 
through  age,  that  they  are  dismantled ;  fifty  mills  of  equal 
capacity  must  be  put  up  each  year  in  order  to  maintain  a 
constant  supply  of  goods.  If  prices  are  so  low  that  not  all 
costs  of  production  are  covered,  no  new  mills  are  erected 
to  take  the  place  of  those  which  are  abandoned,  and  a  part 
of  the  supply  fails.  If  prices  are  above  cost,  instead  of 
fifty  new  mills,  there  may  be  lOO,  and  the  increased  supply 
tends  to  draw  prices  back  toward  the  cost  level.  In  a  new 
industry,  on  the  other  hand,  there  are  no  old  mills  to  dis- 
mantle when  prices  fall,  although  new  mills  may  be  erected 
when  prices  rise. 

9.  /;/  agriculture,  the  uncertainties  of  the  seasons  oftett 
interfere  with  the  operation  of  the  laius  of  normal  price. 

If  the  price  of  wheat  is  high  this  year,  more  than  a 
normal  acreage  will  probably  be  sown  to  wheat  next  year. 
The  average  yield  per  acre  may  be  low  next  year  and  the 


NORMAL    COMPETITIVE    PRICE 


53 


price  of  wheat  may  remain  high,  thus  inducing  farmers  to 
sow  a  still  larger  acreage  the  year  following.  A  succession 
of  good  years  may  then  ensue,  with  the  result  that  prices 
become  abnormally  low  and  the  wheat  acreage  is  much 
reduced.  In  fact,  so  uncertain  are  the  seasons  that 
farmers  often  fail  to  recognize  that  a  given  crop  is  being 
produced  in  excess  of  the  demand  at  remunerative  prices. 
Each  season's  low  prices  come  upon  the  farmer  unawares. 
He  probably  ascribes  them  to  some  cause  other  than  the 
true  one,  and  continues  in  his  course  of  over-production, 
perhaps  for  years.  Conversely,  high  prices  may  be 
ascribed  to  false  causes  —  speculation,  failure  of  crops 
abroad,  etc.  —  and  consequently  fail  to  set  in  motion  the 
corrective  influence  of  expanding  supply.  It  is  only  by 
keeping  in  view  a  number  of  years  that  we  can  discern  a 
normal  price  level  for  agricultural  products. 

10.  Deviatio7is  from  the  noruial  price  level  are  greatest 
where  production  requires  antecedent  preparations  extending 
over  a  period  of  years. 

Every  one  who  has  lived  in  a  fruit-growing  country  has 
had  his  attention  drawn  to  the  extraordinary  returns  some- 
times secured  by  the  owners  of  orchards.  In  parts  of 
California  the  product  of  a  cherry  orchard  may  be  sold, 
on  the  tree,  for  $200  or  more  per  acre,  and  a  failure  of 
the  cherry  crop  is  a  rare  occurrence.  Land  similar  to 
that  upon  which  the  cherry  trees  are  grown  was  recently 
to  be  had  at  $1 50  an  acre  ;  the  cost  of  planting  an  acre,  and 
caring  for  the  young  trees  up  to  the  time  when  they  be- 
come productive,  would  probably  be  covered  by  an  equal 
sum.  A  ^200  return  on  a  $300  investment  looks  very  at- 
tractive, certainly.  Why  do  not  more  persons  enter  the 
business  of  cherry  production }  Because  several  years 
must  elapse  before  they  can  secure  any  returns,  and  in  the 
meantime  the  price  of  cherries  may  fall  so  low  that  there 
would  not  be  even  a  fair  return  in  their  production. 


54 


INTRODUCTION   TO    ECONOMICS 


In  1885  a  Nebraska  landowner  planted  200  acres  of 
catalpa  trees.  In  1907  he  cut  the  trees  and  sold  the 
product  —  posts,  telephone  poles,  and  wood  —  for  a  sum 
which,  after  paying  at  a  liberal  rate  for  all  labor  in  the 
care  of  his  trees  and  in  cutting  and  marketing  them,  yielded 
over  10  per  cent  compound  interest  on  his  original  outlay 
for  land  and  for  planting.  This  is  an  unusually  high  re- 
turn on  landed  investment  in  that  part  of  the  •  country. 
Why  then  do  not  more  men  plant  catalpa  trees  ?  Well, 
who  can  foresee  the  prices  that  will  prevail  twenty  years 
hence  ?  It  is  entirely  conceivable  that  for  a  hundred 
years  or  more  those  who  plant  trees  will  receive  an  abnor- 
mally high  return  on  their  investments.  On  the  other 
hand,  the  business  of  tree  planting  may  easily  be  carried 
to  an  extreme,  with  the  result  that  for  a  long  period  of  time 
those  who  plant  trees  will  receive  practically  no  return. 

11.  Where  several  commodities  are  tJie  result  of  a  single 
process  of  fj-oduction,  it  is  itnpossible  to  determine  the  cost 
of  each  one  separately.  The  group  as  a  ivhole  has  a  normal 
^price ;  the  separate  commodities  have  not. 

Some  commodities  are  invariably  produced  together,  as 
beef  and  hides,  cotton  and  cotton  seed,  wool  and  muttoni. 
In  most  great  industries,  it  is  found  possible  to  make  use 
of  parts  of  the  raw  material  that  are  ordinarily  regarded 
as  waste.  Thus,  in  the  refining  of  petroleum,  besides  the 
main  product,  kerosene,  a  host  of  by-products  —  gasolene, 
lubricants,  tars,  dyes,  etc.  —  are  produced.  How  much 
does  it  cost  to  produce  these }  Nobody  can  tell.  They 
could  not  be  produced  at  all,  in  commercial  quantities, 
were  it  not  for  the  immense  capital  engaged  primarily  in 
the  production  of  kerosene.  Part  of  the  cost  of  the  use 
of  that  capital  ought  to  be  counted  as  cost  of  by-products. 
But  it  is  not  possible  to  say  how  great  that  part  should  be. 
No  one  can  say  how  much  it  costs  to  produce  hides,  or 
cotton  seed,  or  wool.     There  is,  of  course,  an  ascertainable 


NORMAL   COMPETITIVE   PRICE  55 

cost,  and  hence  a  definite  normal  value,  of  live  cattle,  oi 
sheep,  of  unginned  cotton,  of  petroleum  products  as  a 
whole.  If  the  price  of  beef,  added  to  the  price  of  hides,  is 
more  than  reasonable  compensation  for  the  cost  of  raising 
cattle,  the  business  of  cattle-raising  tends  to  expand.  And 
so  with  other  cases  of  joint  products. 

The  same  principle  is  very  clearly  ilkistrated  in  the  busi- 
ness of  transportation.  A  ship  or  a  railway  train  may 
carry  passengers  of  different  classes,  as  well  as  a  wide 
variety  of  baggage  and  freight.  How  much  does  it  cost  a 
railway  company  to  carry  a  particular  passenger  from 
Chicago  to  New  York .-'  From  one  point  of  view  the  cost 
appears  to  be  almost  nothing.  The  train  would  run  even 
if  this  passenger  remained  in  Chicago.  An  empty  seat 
would  be  hauled  from  city  to  city,  instead  of  an  occupied 
one.  The  passenger  adds  his  weight  to  the  load  that  the 
engine  must  draw,  but  a  few  cents  would  easily  cover  this 
cost.  What  is  true  of  one  passenger  is  true  of  any  other; 
he  could  be  carried  for  nothing,  if  the  costs  entailed  by  his 
presence  were  alone  considered.  The  cost  of  running  the 
train,  however,  is  a  very  large  sum,  and  this  is  the  immedi- 
ate cost  of  carrying  the  passengers  as  a  body. 

But  the  cost  of  running  trains  is  not  the  whole  cost  of 
the  service  of  the  railway  company.  The  track  must  be 
kept  in  repair ;  interest  must  be  paid  on  capital  invested  in 
roadbed,  terminals,  etc.  How  much  of  this  cost  is  assign- 
able to  the  passenger  service,  how  much  to  the  freight 
service  ?  It  is  impossible  to  say.  The  entire  service  of  the, 
railway  has  an  ascertainable  cost  and  a  normal  price ;  each, 
separate  service  has  not. 

12.  The  cost  of  production  varies  from  establisJiment  to 
establisJimcjit.  At  any  given  time  norm (7/  price  is  deter- 
mined  by  tJie  costs  of  those  who  prod/ice  /iiider  the  giratesl 
disadvantages,   or  the  marginal  producers. 

Where  the  cost  of  a  particular  commodity  is  ascertain- 


56  INTRODUCTION   TO    ECONOMICS 

able,  and  any  one  is  free  to  enter  upon  its  production,  the 
price  constantly  tends  toward  the  level  of  cost.  Cost,  then, 
may  be  said  to  determine  normal  value.  It  is,  however,  to 
be  borne  in  mind  that  cost  itself  is  something  variable  and 
fluctuating.  Cost  of  production  in  any  industry  is  greater 
for  some  producers  than  for  others.  A  given  grade  of  cot- 
ton goods  may  be  produced  either  in  Rhode  Island  or  in 
North  Carolina.  It  may  cost  an  average  of  ten  cents  a 
yard  in  Rhode  Island,  and  nine  cents  a  yard  in  North 
Carolina.  Some  Rhode  Island  factories  are  better  than 
others ;  perhaps  the  cost  of  producing  the  cloth  is  eight 
cents  in  the  best  factories  and  twelve  cents  in  the  w^orst 
equipped  ones.  And  similar  gradations  may  exist  in  North 
Carolina.  So  when  we  say  that  normal  price  is  fixed  by 
cost  of  production,  exactly  what  do  we  mean .-'  Average 
cost  ?     Greatest  cost .-'     Least  cost  ? 

It  may  be  supposed  that  a  factory  which  produces  at  a 
cost  of  eight  cents  will  run  on  full  time,  and  with  full  work- 
ing force,  if  the  price  is  8^  cents.  If  the  price  is  ten  or 
twelve  cents,  it  can  do  no  more,  unless  it  can  be  expanded 
by  the  erection  of  an  annex.  Let  us  suppose  that  it  would 
take  a  year  to  construct  such  an  annex  and  get  it  into  work- 
ing order.  In  the  meantime  the  factory  produces  as  much  as 
it  can  when  the  price  rises  ;  but  so  it  would  have  done  if  the 
price  had  not  risen.  So  far  as  this  factory  is  concerned, 
the  rise  in  price  does  not  immediately  create  an  expansion 
of  supply  that  reacts  upon  the  price.  This  factory,  then, 
cannot  be  said  to  be  in  a  position  to  control  prices. 

But  let  us  suppose  that  there  are  other  factories  which 
produce  at  a  cost  of  nine,  ten,  eleven,  twelve  cents  a  yard. 
So  long  as  the  price  remains  at  8|  cents,  none  of  these,  we 
may  assume,  will  be  in  operation.  As  soon  as  the  price 
rises  to  nine  cents,  the  factories  producing  at  that  cost  will 
open  their  doors,  and  by  increasing  the  supply  of  goods, 
will  tend  to  check   further  rise  in  prices.     If  prices  rise 


NORMAL    COMPETITIVE    PRICE  57 

nevertheless,  the  factories  producing  at  a  cost  of  ten  cents 
will  begin  operations,  and  will  exert  their  intluence  on 
supply  and  on  price.  When  the  price  rises  to  twelve  cents, 
it  will  be  the  factories  producing  at  this  cost  that  will  tend 
to  check  a  further  rise  in  price.  When  the  price  is  twelve 
cents,  the  costs  of  production  of  the  better  equipped  mills 
—  those  producing  at  eight  and  one  half,  nine,  ten,  and 
eleven  cents  —  have  little  to  do  with  the  determining  of 
price.  If  the  price  rose  a  little  higher,  or  fell  a  httle  lower, 
these  factories  would  continue  to  produce  exactly  as  much 
as  they  do  when  the  price  remains  at  twelve  cents.  They 
do  not,  therefore,  regulate  the  supply.  This  the  twelve- 
cent  mills  do,  since,  if  the  price  falls,  they  are  ready  to  drop 
out,  and  reduce  supply. 

It  is  not  tobe  understood,  however,  that  a  manufacturer  can 
say:  "I  produce  at  a  cost  of  twelve  cents;  I  must  have  at 
least  that  price,"  and  so  force  the  price  up  to  twelve  cents. 
If  the  market  demands  that  manufacturer's  contribution  to 
the  supply,  it  must  pay  twelve  cents  for  every  part  of  the 
supply.  The  manufacturer  in  the  least  favorable  position 
cannot  fix  the  price  at  his  cost.  He  can  only  withhold  what 
he  might  have  supplied,  and  so  bring  to  bear  upon  the 
market  some  small  pressure,  making  for  higher  prices. 

It  is  only  in  a  restricted  sense,  then,  that  we  can  say 
that  normal  prices  are  fixed  by  cost  of  production.  Those 
who  produce  at  a  cost  of  twelve  cents,  by  their  action  in 
placing  a  product  on  the  market  or  withholding  it,  make 
an  attempt  at  holding  the  price  at  that  point.  Perhaps  the 
task  is  too  great  for  them;  the  price  slips  away  ;  and  those 
producing. at  a  cost  of  eleven  cents  make  an  endeavor,  by 
the  same  means,  to  hold  prices  at  their  cost  level.  They 
also  may  be  unequal  to  the  task,  but  at  last  the  price  rests 
in  the  hands  of  producers  who  are  just  able  to  hold  it  at 
their  costs.  We  may  think  of  these  as  being  on  the  fringe 
or  "margin"  of  production;  they  are  often  called,  in 
economics,  the  marginal  producers. 


58  INTRODUCTION   TO    ECONOMICS 

13.  ///  tJie  long  r2in  competitive  prices  tend  toward  tJie  level 
of  cost  of  the  most  cffi,cient  producers. 

The  price  does  not,  however,  rest  permanently  with  the 
same  marginal  producers.  Those  producers  whose  costs 
are  less  than  the  price  are  continually  reaping  profits  ;  they 
invest  them  in  new  mills,  equally  well  equipped,  and  bor- 
row capital  further  to  increase  their  productive  capacity. 
In  time  they  greatly  increase  their  output,  and  this  tends 
to  reduce  the  price  of  the  commodity.  The  marginal  pro- 
ducers find  the  burden  of  holding  the  price  at  their  cost 
level  growing  heavier  and  heavier ;  soon  the  price  breaks 
away  from  them  altogether,  and  is  held  for  a  time  at  the 
cost  level  of  slightly  more  efficient  producers.  But  the 
most  efficient  producers  continue  to  enlarge  their  works ; 
an  increasing  supply  is  thrown  upon  the  market,  and  the 
price  settles  to  a  still  lower  level,  where  it  equals  cost  to 
producers  who  formerly  enjoyed  a  slight  profit.  In  this 
way  prices  are  continually  gravitating  toward  the  level  of 
cost  of  the  most  efficient  producers. 

It  may  therefore  be  said  that  for  a  short  period  price  is 
determined  by  the  costs  of  production  of  those  who  produce 
at  the  greatest  expense,  but  whose  contribution  to  the 
supply  is  necessary  in  order  that  the  existing  demand 
may  be  met.  In  the  progress  of  time,  however,  such  pro- 
ducers are  unable  to  hold  prices  at  their  cost  level,  and  are 
forced  out  of  business.  The  final  adjustment  —  ii  it  should 
ever  be  attained  —  would  leave  price  at  the  level  of  cost  to 
the  most  efficient  producers,  all  of  whom  would  stand  on  a 
plane  of  equality  as  to  costs. 

This  does  not  mean,  however,  that  the  price  of  a  given 
commodity  must  continue  to  decrease.  The  cost  itself 
may  increase,  for  the  more  efficient  as  well  as  for  the  less 
efficient  producers.  As  we  have  used  the  term,  cost  in- 
cludes the  value  of  raw  materials  and  fuel ;  interest  on 
capital,  whether  fixed  in  land,  buildings,  and  machinery,  or 


NORMAL    COMPETITIVE    PRICE  59 

invested  in  raw  materials,  etc.;  wages  of  all  labor  employed; 
and  a  number  of  lesser  items  — taxes,  insurance  premiums, 
etc.  Now,  every  one  of  these  elements  in  cost  is  perpetu- 
ally fluctuating  in  magnitude  according  to  its  own  peculiar 
laws.  The  sources  of  raw  material  may  be  approaching 
exhaustion  ;  wages  and  interest  may  be  rising  ;  taxes  may 
be  growing  heavier.  But  while  such  an  increase  in  costs 
may  prevent  the  more  efficient  factory  from  producing  as 
cheaply  as  before,  it  burdens  the  less  efficient  proportion- 
ately. It  cannot,  then,  prevent  prices  from  tending  toward 
costs  to  the  most  efficient  producer. 

14.    Summary. 

The  market  prices  of  commodities  are  subject  to  con- 
tinual fluctuations.  These  fluctuations  are  greatest  in  the 
case  of  commodities  that  rapidly  deteriorate  and  that  are 
dependent  upon  a  local  market.  Despite  such  fluctuations 
there  is  a  discernible  tendency  toward  a  normal  level  of 
prices.  This  level  is  determined  by  the  cost  of  production. 
The  force  that  causes  market  prices  to  hover  about  cost  of 
production  is  competition  between  the  several  producers. 

The  ease  or  difficulty  with  which  supply  may  be  in- 
creased or  diminished  determines  the  degree  of  possible 
deviation  of  prices  from  the  normal  level.  Marked  devia- 
tions are  frequent  in  the  case  of  agricultural  products, 
since  unforeseen  seasonal  influences  are  constantly  vitiating 
the  calculations  of  the  producers.  Great  deviations  are 
possible  where  production  is  governed  by  calculations' 
looking  to  the  remote  future. 

The  costs  of  production  in  every  industry  vary  consider- 
ably from  establishment  to  establishment.  In  short  periods 
of  time  the  costs  of  those  establishments  which  labor  under 
the  greatest  disadvantage  play  a  chief  part  in  determining 
prices.  In  the  long  run  prices  tend  toward  the  level  of 
cost  of  those  establishments  which  enjoy  the  greatest 
advantages  in  production. 


CHAPTER   IV 
MONOPOLY   PRICE 

1.  TJie  price  of  a  commodity  may  be  controlled  by  dealers 
or  producers  tJirougJi  control  of  supply. 

As  has  been  shown  in  the  preceding  chapter,  the  mechan- 
ism which  keeps  prices  hovering  about  cost  of  production 
consists  in  the  automatic  adjustment  of  supply  to  demand. 
If  price  rises,  supply  increases,  and  thus  price  is  forced 
down  again.  If  then  the  supply  of  a  commodity  can  be 
controlled  by  the  producers,  the  price  is,  in  some  measure, 
also  within  their  control.  With  this  control,  the  producers 
are  in  the  happy  situation  where  they  can,  within  limits,  en- 
rich themselves  at  their  pleasure.  It  is  no  wonder,  then, 
that  producers  and  dealers  from  very  early  times  have 
sought  to  bring  supply  under  control.  Joseph  controlled 
the  total  supply  of  grain  in  Egypt,  we  are  told  ;  he  was 
thereby  enabled  to  charge  whatever  prices  he  pleased,  and 
the  prices  he  fixed  were  such  that  he  got  in  exchange  for 
his  grain  all  the  possessions  that  the  Egyptians  had.  In 
ancient  and  mediaeval  times,  when  roads  were  bad  and  the 
costs  of  carriage  prohibitive,  whoever  should  buy  up  the 
stock  of  grain  in  a  town  would  make  himself  practically 
master  of  the  town.  He  could  measure  out  the  grain  in 
small  quantities,  charging  whatever  prices  seemed  good  to 
him. 

To-day,  as  in  earlier  times,  business  men  are  constantly 
seeking  to  gain  control  over  the  prices  of  the  commodities 
in  which  they  deal.  That  some  are  at  least  partially  suc- 
cessful in  this  is  shown  by  the  great  number  of  articles  the 
prices  of  which  do  not  vary.  Price  control  extends,  how- 
ever, far  beyond  the  field  of  constant  prices.     A  man  who 

60 


MONOPOLY   PRICE  6i 

has  absolute  control  over  the  sale  of  a  commodity  may  be 
expected  to  fix  high  prices  in  times  of  prosperity,  low  prices 
in  times  of  depression,  and  in  many  cases  this  policy  ap- 
pears to  be  followed  by  those  men  who  now  have  practical 
control  of  the  prices  of  the  commodities  which  they  sell. 

2.  Power  to  control  prices  is  commonly  termed  monopoly. 

In  the  strictest  sense  of  the  term,  monopoly  is  the  exclu- 
sive privilege  of  selling  a  commodity  or  a  service.  Most 
governments  have  a  monopoly,  in  this  sense,  of  the  postal 
service.  Some  governments  monopolize  the  sale  of  to- 
bacco; others,  the  sale  of  salt;  still  others,  the  sale  of 
spirituous  liquors.  The  exclusive  privilege  of  sale  is  some- 
times granted  by  government  to  private  individuals  or  cor- 
porations. A  common  example  of  this  kind  of  monopoly 
is  the  patent  by  which  an  inventor  is  assured  control  over 
the  use  of  his  invention,  or  the  copyright  by  which  an 
author  is  given  control  over  the  sale  of  his  book.  In  many 
cases  a  private  corporation  is  given  the  exclusive  right  to 
supply  a  city  with  water,  gas,  or  electric  light.  In  some 
cities  only  one  street  railway  company  is  chartered,  and 
in  some  countries  steam  railway  companies  are  given 
monopolies  of  the  transportation  service  within  specified 
areas.  Monopolies  created  by  law,  then,  are  both  numer- 
ous and  important.  In  a  democratic  state  they  are  not 
likely  to  grow  into  a  serious  abuse ;  in  a  state  where  the 
government  is  not  really  controlled  by  the  people,  such 
monopolies  may  become  exceedingly  oppressive. 

3.  A  partial  monopoly  can  be  established  by  private 
persons,  through  agreements  fixitig  prices  or  limiting  supply. 

Let  us  suppose  that  the  producers  of  a  given  com- 
modity agree  among  themselves  not  to  sell  below  a 
certain  price,  or,  what  leads  to  the  same  result,  not  to 
produce  more  than  an  amount  so  small  as  to  com- 
mand scarcity  prices.  If  producers  are  few  —  say  half  a 
dozen  —  such    an    agreement   may    stand.      No   one   can 


62  INTRODUCTION   TO   ECONOMICS 

materially  increase  his  sales  without  attracting  attention ; 
moreover,  no  one  can  increase  his  sales  without  an  immedi- 
ate effect  on  price.  If  the  producers  number  millions, 
such  an  agreement  is  empty  words ;  almost  any  one  can 
violate  it  without  detection,  and  without  any  appreciable 
effect  on  price.  And  the  number  of  violators  of  the  agree- 
ment will  be  so  great  that  no  control  of  supply  or  of 
price  can  be  exercised. 

When  the  number  of  producers  is  small,  then,  there 
may  be  effective  control  of  supply.  But  such  control 
cannot  long  be  retained  unless  new  producers  can  be 
kept  out  of  the  field. 

The  producers  of  cotton  yarn  of  the  higher  grades  are 
not  very  numerous.  It  is  therefore  conceivable  that  they 
might  agree  to  limit  supply  and  force  the  price  to  a  point 
paying  a  "fair"  profit.  But  it  is  not  a  difficult  matter 
to  build  and  equip  a  mill  to  produce  a  given  grade  of 
cotton  yarn.  If,  then,  the  price  were  forced  to  a  high 
level,  new  producers  would  soon  appear.  These  would 
enjoy  the  benefit  of  the  high  price,  although  to  effect  sales 
they  would  have  to  cut  prices  slightly.  The  original 
producers  would  have  to  reduce  their  prices ;  the  new  pro- 
ducers would  then  cut  still  lower,  and  so  on  until  the 
price  had  reached  cost  of  production.  Indeed,  the  price 
would  almost  certainly  go  lower  than  this,  for  the  number 
of  producers,  each  striving  to  get  more  customers,  would 
have  increased.  The  last  state  of  the  cotton  yarn  business, 
accordingly,  would  be  far  worse  than  its  first.  We  have 
had  in  America  not  a  few  examples  of  attempted  monopo- 
lies which  in  the  end  merely  intensified  competition. 

4.  Permanent  price  control  may  be  secured  through  con- 
tjvl  over  some  element  essential  to  pj'odtiction,  such  as  labor, 
razv  material,  means  of  transportation. 

If  the  industry  which  it  is  sought  to  monopolize  requires 
a  very  high  grade    of  skilled  labor,  and  the  members  of 


MONOPOLY   PRICE  63 

the  combination  control  the  whole  supply  of  labor  of  this 
grade,  the  monopoly  may  rest  secure  until  new  labor 
can  be  trained  for  the  shoi)s  of  would-be  competitors. 
If  the  only  satisfactory  way  of  training  such  labor  is 
through  apprenticeship  under  men  already  working  in 
the  trade,  it  becomes  difihcult  indeed  for  a  competitor  to 
get  an  independent  supply  of  labor.  This  situation  might 
become  a  serious  one  in  some  industries  were  it  not  for 
the  fact  that  it  is  not  easy  for  one  set  of  employers 
permanently  to  control  their  workmen.  The  latter  know 
'that  at  any  time  they  can  thwart  their  employers'  mo- 
nopolistic schemes  by  accepting  employment  with  com- 
petitors; and  this  knowledge  is  made  good  use  of,  in 
forcing  constantly  higher  wages.  Where  monopolies  of 
this  kind  have  arisen,  they  have  generally  been  broken 
up  on  account  of  disputes  between  the  employers  and 
their  workmen. 

Some  products  depend  upon  supplies  of  raw  material 
that  are  found  in  comparatively  few  parts  of  the  earth, 
and  in  limited  quantity.  If  a  combination  of  producers 
can  get  possession  of  all  or  most  of  the  mining  or  agricul- 
tural lands  which  are  capable  of  yielding  a  certain  product, 
they  may  win  their  desired  freedom  from  the  danger  of 
new  competitors.  Anthracite  coal,  for  example,  is  found 
only  in  a  restricted  area  in  the  United  States.  A  combi- 
nation of  capitalists  of  very  great  wealth  might  with 
comparative  ease  control  the  total  output  —  and  indeed, 
something  of  the  kind  now  exists.  Such  a  combination 
has  nothing  to  fear  from  new  competitors,  although  of 
course  it  must  meet  the  competition  of  producers  of  other 
fuels. 

In  the  history  of  the  American  petroleum  industry, 
there  was  a  time  when  the  Standard  Oil  Company,  through 
ownership  of  pipe  Hues,  enjoyed  an  immense  advantage 
over  its  competitors,  who  were  compelled  to  ship  petroleum 


64  INTRODUCTION   TO   ECONOMICS 

over  the  railways.  The  Standard  Oil  Company  was  not, 
indeed,  enabled  by  this  advantage  to  destroy  competition 
entirely ;  its  control  over  supply  was,  however,  notably 
strengthened  by  the  ownership  of  the  pipe  lines. 

5.  Perma7ient  price  cojitrol  is  sometimes  inaintained 
through  the  systematic  intimidation  of  competitors. 

Let  us  suppose  that  there  is  a  combination  of  the  more 
important  producers  of  coal,  who  yet  have  nothing  like 
complete  ownership  of  the  coal  lands,  and  that  there  are 
a  number  of  small  competitors  whose  natural  market  is  a 
city  which  we  will  call  X.  Other  markets,  we  will  assume; 
are  so  far  distant  that  cost  of  transportation  prohibits  their 
supply  from  the  mines  of  the  small  producers.  The  com- 
bine, let  us  say,  has  mines  from  which  it  can  supply  the 
market  X,  as  well  as  a  great  number  of  mines  supplying 
other  cities.  If,  then,  it  desires  to  destroy  the  business  of 
its  small  competitors,  it  may  decide,  for  a  while,  to  sell  coal 
in  X  for  less  than  the  cost  of  raising  it  from  the  pit.  This 
the  combination  can  afford  to  do,  because  it  is  enjoying 
high  profits  from  its  monopolistic  position  in  the  supplying 
of  other  markets.  Of  course  the  small  competitors  can  sell 
no  coal  at  prices  which  will  meet  those  of  the  combine ; 
very  soon  they  become  discouraged  and  retire  from  busi- 
ness. Then  the  combine  can  raise  prices  of  coal  in  X  to 
a  profit-yielding  point.  The  small  producers  will  probably 
not  again  attempt  to  compete,  knowing  that  the  same  tactics 
will  again  be  employed  to  destroy  their  business. 

Of  course,  if  coal  were  easy  to  transport,  this  method 
would  prove  very  expensive  to  the  monopolistic  combina- 
tion. An  enterprising  dealer  in  the  town  X,  finding  that 
the  combination  sold  coal  there  at  much  lower  prices  than 
in  town  Y,  might  buy  up  coal  in  the  former  place  and  ship 
it  to  the  latter.  On  every  ton  of  coal  sold  in  X,  we  have 
assumed,  the  combination  is  losing  money  ;  and  every  ton 
sold  in  Y  helps  to  depress  the  price  there,  to  the  further 


MONOPOLY    PRICE  6$ 

disadvantage  of  the  combine.  In  a  sense,  it  would  be 
underselling  itself. 

Accordingly,  some  other  method  of  destroying  competi- 
tors must  be  employed  when  the  commodities  which  it  is 
sought  to  monopolize  are  of  little  weight  and  bulk,  as  com- 
pared with  their  value,  and  hence  easily  transported.  Sup- 
pose that  a  monopolistic  combination  controls  most  of  the 
manufacture  of  cigars,  and  that  an  overbold  outsider,  anx- 
ious to  share  the  benefits  of  high  prices,  enters  the  field. 
He  may  place  on  the  market  an  excellent  brand  of  cigars, 
charging  for  them  less  than  the  combine  charges  for  similar 
ones.  The  combine  cannot  lower  the  prices  of  all  cigars 
in  the  competitor's  vicinity,  for  in  that  case  dealers  will  buy 
them  up  and  express  them  to  all  parts  of  the  country  ;  and 
thus  the  combine  will  be  inflicting  losses  upon  itself.  But 
there  is  another  method  which  it  may  find  efficacious. 

Let  us  say  that  the  independent  producer  calls  his  brand 
of  cigars  the  "  Rex."  It  is  his  all ;  his  fortune  is  bound  up 
with  its' fate.  The  combine  has  500  brands;  it  makes 
profits  on  all  of  them.  Accordingly,  it  can  afford  to  put 
out  a  new  brand  of  cigars  —  say  the  "  Regina  "  —  for  half 
the  price  of  the  Rex,  though  of  as  good  quality,  and  place 
it  on  the  market  wherever  the  Rex  is  sold.  Before  long 
the  Rex  is  no  longer  purchased ;  its  producer  goes  out  of 
business.  Then  the  combine  puts  worse  tobacco  into  the 
Regina,  until  at  last,  like  all  its  other  products,  this  cigar 
is  dear  at  the  price. 

6.-  Monopolies  tJiat  arc  not  based  upon  privileges  granted 
by  government  arc  rarely  complete,  and  consequently  are 
influenced  in  the  fixing  of  prices  by  fear  of  competition. 

To  destroy  a  competitor  is  a  proceeding  that  almost 
always  involves  heavy  expense.  If  a  powerful  combina- 
tion desires  to  destroy  a  small  but  vigorous  competitor,  it 
is  often  obliged  to  sell  below  cost,  not  only  to  those  per- 
sons who  actually  deal  with  the  competitor,  but  also  to 


X 


66  INTRODUCTION   TO   ECONOMICS 

many  other  persons  in  the  same  market.  The  combination 
can  compel  its  competitor  to  lose  money,  but  in  so  doing  it 
loses  money  itself  —  sometimes  ten  dollars  for  every  dollar 
its  competitor  loses.  Accordingly,  it  is. often  cheaper  for 
a  combination  to  buy  up  the  plant  of  a  competitor,  even  at 
an  unreasonably  high  price,  than  to  force  the  plant  to  close 
down  through  price-cutting.  If  the  competitor  refuses  to 
sell  to  the  combination,  the  latter  may  adopt  a  "  live  and 
let  live  "  policy,  agreeing  to  respect  the  competitor's  right 
to  his  territory  and  established  trade,  so  long  as  he  does 
not  appear  obnoxiously  active  in  increasing  his  business. 
All  the  great  American  trusts  have  competitors  toward 
whom  they  observe  a  policy  of  toleration.  The  trust  sets 
a  price  upon  its  products,  and  the  independenTTOncemll 
sells  at ^:he-same-pri€e.  If,  however,  this  price  is  so  high 
as  to  offer  great  profits,  the  independent  concerns  grow 
stronger  and  stronger,  and  in  the  end  extend  their  business, 
encroaching  upon  the  field  of  the  monopoly. 

It  is  not  alone  the  competition  of  the  existing  independ- 
ent concerns  that  a  monopoly  has  to  fear.  Very  high 
prices  are  likely  to  induce  new  competitors  to  enter  the 
field.  Such  competitors  must  either  be  driven  from  the 
field  by  the  expensive  policy  of  price-cutting,  or  some  of 
the  business  of  the  monopoly  must  be  surrendered  to  them. 
In  fixing  prices,  then,  the  monopolist  must  have  regard  not 
only  for  actual  competition,  but  also  for  such  competition 
as  might  arise,  or  potential  competition. 

7.  A  complete  monopoly  will  fix  prices  at  a  level  .that 
yields  the  maximum  return  above  all  costs. 

Suppose  that  a  monopoly  has  complete  control  of  the 
salt  that  is  to  be  sold  in  the  United  States.  It  may  cost 
one  cent  a  pound  to  produce  it.  At  what  price  will  the 
monopoly  sell  it.-'  If  the  price  is  one  cent,  perhaps  one 
billion  pounds  can  be  sold.  If  the  price  were  raised  to 
two  cents,  who  would  eat  his  food  unsalted.''     Who  would 


MONOPOLY    PRICE  '  67 

economize  salt  in  the  least?  It  is  safe  to  say  that  there 
are  few  persons  in  the  United  States  so  poor  that  they 
would  not  go  on  eating  as  much  salt  as  before.  And  the 
same  thing  would  be  true  if  the  price  were  raised  to  five 
cents  a  pound  —  a  price  of  which  four  fifths  would  be 
monopoly  profit. 

But  not  all  the  salt  is  for  table  use ;  a  large  part  of  the 
total  supply  is  used  for  live  stock  and  for  manufacturing 
purposes.  If  the  price  of  salt  rises,  the  use  of  it  for  these 
purposes  declines.  When  salt  is  very  cheap  many  farmers 
scatter  it  on  the  ground  for  their  cattle,  or  leave  it  in 
troughs  with  no  shelter,  where  the  weather  devours  more 
of  it  than  do  the  cattle.  High  price  would  mean  econ- 
omy. So,  at  two  cents  a  pound,  probably  not  more  than 
900,000,000  pounds  will  be  used,  instead  of  1,000,000,000. 
At  five  cents  a  pound  the  amount  taken  might  shrink  to 
800,000,000  pounds;  at  ten  cents,  to  700,000,000;  at 
twenty,  to  500,000,000.  Were  the  price  forced  up  to  $1  a 
pound,  very  likely  great  economy  would  be  exercised  even 
in  the  use  of  salt  in  human  food.  Perhaps  not  more  than 
80,000,000  pounds  would  be  used. 

Now,  while  the  monopoly  would  make  the  enormous 
profit  of  ninety-nine  cents  a  pound  at  the  last-mentioned 
price,  this  would  be  a  very  irrational  price  for  it  to  set. 
The  total  profit  from  the  sale  of  salt  would,  according  to 
our  assumed  volume  of  sales,  be  $79,200,000.  And  this 
would  be  much  better  than  selling  1,000,000,000  pounds  at 
cost,  or  900,000,000  at  two  cents.  The  latter  price  would 
yield  just  $9,000,000  profit.  At  five  cents  the  monopoly 
would  get  a  profit  of  $32,000,000;  at  ten  cents,  of 
$63,000,000;  at  twenty  cents,  of  $95,000,000.  So  twenty 
cents  is  really  a  more  profitable  price  for  the  monopoly 
than  $1.  At  twenty-five  cents,  however,  400,000,000 
pounds  might  be  taken ;  and  this  would  mean  a  profit 
aggregating  $96,000,000.     This,  then,  is  a  still  better  price 


68  INTRODUCTION  TO   ECONOMICS 

than  twenty  cents,  from  the  monopolists'  point  of  view. 
Let  us  suppose  that  at  thirty  cents  300,000,000  pounds 
will  be  taken.  The  profit  at  this  price  would  amount  to 
only  $87,000,000.  This  price,  accordingly,  is  too  high ; 
and  the  best  price  for  the  monopolist  lies  between  twenty- 
five  and  thirty  cents. 

Of  course  this  would  be  an  exorbitant  price ;  and  far 
more  extortionate  than  any  existing  monopoly  price.  But 
given  the  conditions  —  a  complete  monopoly  of  salt  —  ex- 
tortionate prices  can  be  established.  One  must  have  salt ; 
he  must  have  a  certain  amount  of  it.  There  is  nothing  in 
the  world  that  can  be  substituted  for  it.  And  even  if  the 
price  were  exorbitant,  the  cost  of  salt  would  form  no  very 
large  item  in  any  one's  expenditure.  No  one  would  leave 
the  country  to  escape  the  monopoly. 

8.  The  greater  tJie  elasticity  of  demand  for  commodities 
controlled  by  monopolies,  the  loiver  ivill  be  the  price  that 
yields  the  m.aximnm  monopoly  profit. 

The  demand  for  salt  is  peculiarly  inelastic.  To  do 
without  salt  altogether  is  impossible;  to  reduce  consump- 
tion always  involves  hardship.  Most  other  commodities 
can  be  replaced  by  substitutes.  One  kind  of  food  readily 
takes  the  place  of  another ;  cottons  may  be  replaced  by 
woolens,  linens,  and  silks  ;  wood  for  building  purposes  may 
give  way,  in  large  degree,  to  stone,  brick,  and  concrete. 
There  is  almost  always  an  ill-defined  boundary  between 
the  consumption  of  one  commodity  and  that  of  another, 
and  changes  in  relative  prices  shift  the  boundary  now  in 
one  direction,  now  in  another. 

Let  us  suppose  that  a  monopoly  has  gained  control  of 
the  entire  supply  of  beef  in  the  United  States.  Perhaps 
the  cost  price  at  which  beef  can  be  placed  on  the  market 
is  ten  cents  a  pound.  With  beef  at  this  price,  the  Ameri- 
can people  might  conceivably  eat  100  pounds  per  capita  — 
8,000,000,000  pounds  in  round  numbers.     At  eleven  cents, 


MONOPOLY    PRICE  69 

some  of  the  poorest  people  would  cease  eating  beef  and 
use  mutton  or  pork  instead,  or  use  less  meat  of  any- 
kind.  Perhaps  the  amount  consumed  would  fall  to 
7,000,000,000  pounds.  That  would  give  the  beef  mo- 
nopoly a  princely  income  —  $70,000,000.  At  twelve  cents 
the  amount  consumed  might  fall  to  6,000,000,000  pounds  ; 
but  this  would  yield  a  net  profit  of  $120,000,000;  and  if 
the  amount  at  thirteen  cents  fell  to  5,000,000,000  pounds, 
the  profit  would  yet  amount  to  $150,000,000.  Fourteen 
cents  and  4,000,000,000  pounds  would  be  still  better  for 
the  monopoly  —  $160,000,000.  But  fifteen  cents  and 
3,000,000,000  pounds  would  be  a  step  backward,  for  the 
profit  would  be  only  $150,000,000.  Fourteen  cents,  then, 
is  the  most  that  the  monopoly  could  wisely  charge. 

Of  course,  if  the  demand  does  not  shrink  so  rapidly  as  I 
have  assumed,  the  maximum  price  can  safely  be  placed 
at  a  higher  figure.  If  the  shrinkage  is  more  rapid  than  I 
have  assumed,  fourteen  cents  is  too  high. 

As  the  number  of  commodities  offered  to  the  public  for 
consumption  is  continually  increasing,  it  is  safe  to  say  that 
the  average  consumer  grows  less  and  less  dependent  upon 
any  one.  Demand,  accordingly,  grows  constantly  more 
elastic,  and  the  power  of  monopolies  to  fix  prices  at  a  high 
level  constantly  diminishes. 

9.  In  fixing  prices,  a  monopoly  is  more  or  less  extortionate 
according  as  it  pays  less  or  more  attention  to  tJte  ulterior 
ejfects  of  JdgJi  prices. 

If  it  is  the  intention  of  the  monopolist  simply  to  exploit 
the  beef  market  for  one  year,  —  to  corner  the  present  sup- 
ply, make  the  most  out  of  it,  and  then  retire  to  hve  on  his 
plunder,  —  he  may  find  that  at  fourteen  cents  there  will  be 
no  greater  shrinkage  of  demand  than  has  been  assumed  in 
the  foregoing  example,  and  this  will  then  be  the  best  price 
for  him  to  set.  Most  persons  who  are  accustomed  to  this 
article  of  diet  will  continue  to  buy  it  even  at  the  higher 


yo  INTRODUCTION   TO   ECONOMICS 

price.  But  in  a  year  more  and  more  of  them  will  form 
other  habits.  A  corner  in  beef  organized  in  the  following 
year  might  not  be  able  to  charge  more  than  twelve  cents 
without  diminishing  total  net  profit ;  and  in  the  third  year 
a  corner  might  not  be  able  to  charge  more  than  eleven 
cents.  Accordingly,  a  monopolist  who  does  not  mean  to 
retire  from  business  must  generally  avoid  charging  a  price 
that  would  give  the  highest  possible  returns  for  one  year. 
He  must  fix  prices  in  such  a  way  as  to  keep  the  bulk  of  his 
custom  from  year  to  year.  And  this  is  one  reason  why 
modern  monopolists  are  less  extortionate  than  the  ancient 
and  mediaeval  "  engrossers "  of  the  necessaries  of  life. 
As  a  rule,  the  modern  monopolist  hopes  for  steadily  in- 
creasing profits  from  a  growing  business ;  he  therefore 
cultivates  his  clientele  through  prices  that  are  moderate. 

If  a  ring  of  speculators  of  immense  wealth  should  buy  up 
the  entire  American  cotton  crop,  they  could  fix  the  price 
of  cotton  at  twice  the  normal  price,  and  yet  sell  most  of  it. 
Cotton  fabrics  would  advance  in  price,  but  not  proportion- 
ately, for  many  persons  would  go  without  cotton  cloth 
rather  than  pay  unreasonably  high  prices.  The  profits  of 
cotton  manufacturers  would  fall ;  wages  of  cotton  opera- 
tives would  be  reduced.  The  cotton  manufacture  would 
decline ;  many  cotton  operatives  would  go  into  other  em- 
ployments. Cotton  production  in  Egypt,  India,  and  Aus- 
tralia would  be  stimulated.  It  would  take  more  than  a 
year,  however,  for  such  adjustments  to  take  place.  In  the 
meantime  the  speculators  would  have  sold  their  cotton 
at  high  prices,  and  reaped  their  extortionate  profits.  The 
injury  occasioned  by  the  changes  in  cotton  manufacture 
would  fall  upon  the  producers  of  the  succeeding  American 
cotton  crops. 

If  a  combination  of  capitalists  were  to  secure  possession 
of  the  entire  business  of  petroleum  refining,  it  would  be  no 
less  easy  for  them  to  obtain  exorbitant  profits  for  one  year. 


MONOPOLY    PRICE  71 

But  the  decline  in  consumption  that  would  follow,  when 
time  had  been  given  the  people  to  provide  themselves  with 
other  sources  of  light  and  power,  would  seriously  impair 
the  future  profits  of  the  petroleum  monopoly.  Now,  no 
profit,  however  exorbitant,  on  a  single  year's  sales,  is  to  be 
compared  with  comfortably  high  profits  for  an  indefinite 
series  of  years.  Great  fortunes  are  to  be  obtained  through 
the  permanent  monopolization  of  the  means  of  producing 
a  commodity,  rather  than  through  cornering  the  visible 
supply  and  exacting  excessive  prices,  without  regard  to  the 
effect  of  the  policy  on  future  sales.  For  this  reason  mo- 
nopolies of  the  permanent  kind  are  continually  increasing 
in  number  and  importance,  while  it  is  only  rarely  that  a 
temporary  monopoly  is  successfully  carried  through. 

10.  ///  order  to  secure  the  maxiiniim  profit,  a  monopolist 
often  endeavors  to  classify  cons?imers,  and  to  burden  each 
class  according  to  its  ability  to  pay  high  prices. 

There  are  some  classes  of  consumers  who  will  pay  in- 
creased prices  without  a  murmur,  while  other  classes  will 
not  only  feel  greatly  aggrieved,  but  will  even  refuse  to  buy, 
when  prices  are  appreciably  increased.  To  the  rich  it 
makes  little  difference  whether  beef  is  high  or  low.  If  the 
monopoly  can  array  its  customers  in  groups,  according  to 
their  readiness  to  pay  high  prices,  it  can  grade  its  prices 
accordingly.  The  classes  that  will  endure  only  a  slight 
increase  in  price  are  given  prices  so  moderate  that  they 
continue  to  buy,  while  the  classes  that  are  less  apt  to  com- 
plain over  an  increase  are  forced  to  pay  prices  that  yield 
a  higher  profit.  This  is  much  better  for  the  monopoly 
than  to  fix  an  average  price  which  drives  away  the  former 
classes,  and  does  not  exploit  the  latter  to  the  highest 
possible  degree. 

How,  then,  can  a  monopoly  make  such  a  division  of  its 
customers  into  classes  according  to  their  profit-yielding  ca- 
pacity .''     One  way  consists  in  different  prices  for  different 


72  INTRODUCTION   TO   ECONOMICS 

localities.  If  there  is  greater  per  capita  wealth  in  Cali- 
fornia than  in  North  Dakota,  a  monopoly  would  charge 
higher  prices  in  the  former  than  in  the  latter  state,  even 
allowing  for  all  costs  of  transportation.  Suppose  that  the 
cost  of  production  of  beef  for  North  Dakota  is  ten  cents, 
and  the  cost  of  transportation  practically  nothing  ;  the  cost 
of  production  of  beef  for  California  we  may  assume  is  the 
same,  and  the  cost  of  shipping  two  cents  a  pound.  The 
beef  may  be  sold  in  Dakota  for  eleven  cents  and  for  fifteen 
in  California  —  giving  a  net  profit  of  one  cent  in  the  for- 
mer state  and  three  in  the  latter.  Of  course,  the  difference 
could  be  as  great  as  this  only  in  case  shipping  beef  in  small 
quantities  is  expensive;  otherwise  outsiders  would  buy 
beef  in  Dakota  at  eleven  cents,  ship  it  to  California,  and 
make  a  good  profit.  And  here  we  have  one  limitation  upon 
a  monopoly's  power  to  vary  its  charges  for  different  locali- 
ties. The  difference  cannot  permanently  remain  at  a  figure 
which  is  greater  than  the  sum  an  outsider  would  have  to 
pay  in  transporting  the  monopoly's  goods  from  the  point 
where  they  are  cheap  to  the  point  where  they  are  dear. 

In  the  case  of  many  goods,  however,  different  qualities 
are  sold  to  different  classes  of  consumers.  The  choicest 
cuts  of  meat  go  to  one  set  of  consumers,  and  the  remain- 
ing cuts,  in  order  of  toughness,  to  the  various  sets  of  con- 
sumers who  have  less  to  spend.  Now  the  consumers  of 
the  cheapest  beef  may  stand  a  slight  increase  in  price 
before  substituting  something  else  for  beef ;  while  those 
who  consume  the  best  quality  may  see  the  price  double 
before  substituting  even  a  cheaper  grade.  The  far-sighted 
monopolist,  then,  instead  of  increasing  the  prices  of  all 
grades  uniformly,  will  so  distribute  the  increase  of  price  as 
to  burden  each  class  of  customers  as  much  as  they  will 
bear  without  withdrawing  custom. 

In  some  cases  where  no  real  differences  in  quality  exist, 
the  consumer  is  made  to  believe  that  there  are  such  differ- 


MONOPOLY    PRICE  73 

ances.  Some  years  ago  —  and  perhaps  to-day  —  there  were 
several  grades  of  salt  on  the  market,  selling  at  different 
prices.  The  manufacturer  who  produced  them  has  ad- 
mitted that  they  were  all  exactly  the  same.  The  classes 
who  could  afford  to  pay  high  prices  for  salt  bought  the 
grade  that  was  alleged  to  be  the  best;  those  who  could 
pay  less  bought  cheaper  grades.  Thus  the  manufacturer, 
who  enjoyed  a  limited  monopoly,  was  able  to  make  each 
class  of  consumers  pay  according  to  ability.  It  is  easy  to 
see  how  far  this  principle  might  be  carried  in  the  case  of 
such  articles  as  soap,  chocolate,  canned  goods.  It  is  a 
wise  man  who  knows  what  ingredients  go  into  these  com- 
modities ;  and  if  the  manufacturer,  who  must  know,  says 
that  one  is  purer  and  more  choice  than  another,  what  can 
you  or  I  do  but  accept  his  statement  and  pay  the  higher 
price  for  the  so-called  better  quality  ? 

11.  A  Dioiiopoly  viay  iiiaiiitain  prices  at  a  higJicr  level  in 
the  domestic  market  than  in  foreign  markets. 

A  few  years  ago  a  New  York  dealer  offered  for  sale 
a  considerable  stock  of  watches  of  a  standard  American 
make  at  prices  far  lower  than  are  commonly  charged  by 
the  manufacturer  in  the  same  city.  These  watches  had 
been  purchased  in  England  at  such  low  prices  that  the 
dealer  was  able  to  make  a  handsome  profit  in  bringing 
them  back  to  America  and  selling  them  at  cut  prices.  It 
is  well  known  that  American  agricultural  machinery  is 
often  sold  more  cheaply  in  foreign  countries  than  at  home, 
in  spite  of  the  cost  of  shipping.  The  German  steel  com- 
bination sells  steel  to  the  British  consumer  more  cheaply 
than  to  the  German  consumer,  and  the  American  steel 
trust  is  frequently  charged  with  a  similar  discrimination 
in  favor  of  foreign  purchasers.  The  principle  is  a  fairly 
common  one  ;  it  is  probable  that  of  the  American  monopo- 
lies that  have  invaded  foreign  markets  there  are  few  that 
have  not  in  some  degree  employed  this  principle. 


74  INTRODUCTION   TO   ECONOMICS 

Such  discriminations  are  to  be  explained  by  the  fact  that 
for  one  reason  or  another  the  domestic  consumer  can  be 
made  to  pay  higher  prices  than  the  foreign  consumer  will 
tolerate.  In  some  cases  the  American  consumer  can  be 
made  to  pay  higher  prices  simply  because  he  is  more 
addicted  to  careless  expenditure.  This  explains  price  dis- 
criminations in  the  case  of  such  articles  as  watches,  razors, 
pipes,  etc.  In  other  cases  the  foreign  consumer  is  favored 
because  he  can  avail  himself  of  the  competition  of  foreign 
producers,  who  are  excluded  from  the  American  market 
by  our  customs  duties.  This  explains  price  discriminations 
in  such  products  as  steel  rails  In  yet  other  cases  the 
discrimination  is  explained  by  the  fact  that  the  foreign 
consumer  has  access  to  a  greater  number  of  substitutes 
than  the  domestic  consumer. 

12.  Ill  railway  transportatio7i,  the  principle  of  discrimi- 
natory charges  is  very  tvidely  employed  under  the  name  of 
'■^charging  ivhat  the  traffic  zvill  bear.'' 

Almost  every  railway  is,  in  a  limited  sense,  a  monopoly. 
It  may  encounter  competition  at  important  business  cen- 
ters, but  most  small  cities  and  towns  are  absolutely  de- 
pendent upon  a  single  line.  Leaving  out  of  account 
public  regulation  of  railway  rates,  we  may  say  that  the 
railway  will  burden  each  class  of  shippers  according  to 
the  ability  of  that  class  to  pay.  The  shippers  of  silks 
can  be  made  to  pay  a  high  rate  per  ton  mile ;  the  ship- 
pers of  bricks  must  have  a  low  rate,  or  it  will  be  impos- 
sible for  them  to  remain  in  business  at  all.  If  allowed  to 
pursue  its  own  devices  in  rate  making,  the  railway  would 
naturally  discriminate  between  the  different  producers  of 
the  same  commodity.  The  owner  of  a  well-situated  mill 
would  be  forced  to  pay  a  higher  rate  than  the  owner  of 
a  mill  badly  situated.  The  owner  of  a  rich  farm  would  be 
made  to  pay  a  higher  rate  than  the  owner  of  a  poor  farm. 
The  shipper  who  is  in  a  position  to  avail  himself  of  the 


MONOPOLY    PRICE  75 

competition  of  a  rival  line  would  receive  better  rates  than 
the  shipper  who  can  use  one  line  only.  The  last  form  of 
discrimination  has  been  exceedingly  common  ;  it  is  not  yet 
extinct,  though  under  the  ban  of  the  law. 

13.  Monopolies  must  endeavor  to  preserve  their  customers* 
prosperity,  and  to  assist  tJieni  in  meeting  competition. 

In  spite  of  the  fact  that  railways  hold  a  monopoly  po' 
sition,  and  avail  themselves  of  the  principle  of  discrimi- 
natory charges,  it  is  very  seldom  that  a  railway  secures 
excessive  profits.  This  is  because  the  demand  for  railway 
service  is  extremely  elastic.  A  high  general  level  of  rates 
"  kills  business."  The  fruit  of  Southern  California  must  be 
carried  to  the  Eastern  market  over  a  single  line  of  railway. 
But  that  railway  cannot  raise  rates  on  fruit  to  a  very  high 
level  without  destroying  the  business  of  fruit  culture  in 
California.  Though  the  railway  itself  has  no  competitor, 
the  fruit  growers  are  engaged  in  an  active  competition  with 
those  of  Florida  and  the  West  Indies,  and  the  railway  must 
make  it  possible  for  its  customers  to  hold  their  own. 

In  like  manner,  a  monopoly  of  anthracite  coal  must  sell 
this  fuel  at  a  price  so  low  that  manufacturers  using  an- 
thracite are  not  seriously  handicapped  in  their  competition 
with  manufacturers  in  other  parts  of  the  country  who  use 
bituminous  coal.  A  monopoly  of  tin  cans  would  have  to 
fix  prices  at  a  level  low  enough  to  permit  the  industry  of 
preserving  fruit  to  hold  its  ground  against  the  business  of 
drying  fruit.  The  lumber  dealers  of  a  town  may  have  an 
inviolable  agreement  fixing  prices,  but  they  will  not  place 
prices  so  high  as  to  handicap  the  town  in  its  competition 
for  population  and  business.  Monopoly  prices,  therefore, 
are  not  likely  to  be  ruthlessly  exorbitant.  They  are  usu- 
ally not  higher  than  the  customers  of  the  monopolies  can 
pay  without  serious  impairment  of  their  power  of  survival. 
None  the  less  they  are  higher  than  they  should  be,  and 
enable  those  who   hold   a  monopoly  position   to  draw  to 


76  INTRODUCTION   TO    ECONOMICS 

themselves  a  larger  share  of  the  social  income  than  their 
services  justify. 

14.    Summary. 

Monopoly  is  attained  through  the  control  of  the  supply 
of  a  commodity  or  a  service.  This  control  may  be  secured 
through  governmental  restrictions  or  through  private  agree- 
ments fixing  prices  or  limiting  output.  Monopolies  resting 
merely  upon  the  agreements  of  independent  producers  are 
inherently  weak. 

If  some  essential  element  in  the  production  of  a  good  can 
be  controlled  by  a  single  enterpriser  or  by  a  group  of  enter- 
prisers who  are  able  to  work  in  complete  harmony,  a  well- 
nigh  impregnable  monopoly  may  be  established.  A  high 
degree  of  monopoHstic  control  is  often  attained  through  in- 
timidation of  competitors.  Monopolies  are  seldom  entirely 
free  from  competitors,  and  hence  are  compelled  to  fix  prices 
at  a  level  which  offers  slight  inducement  to  competition. 

A  complete  monopoly  will  fix  prices  with  a  view  to  se- 
curing the  greatest  aggregate  return  from  the  entire  busi- 
ness. The  more  elastic  the  demand  for  a  commodity,  the 
lower  will  be  the  price  which  affords  the  maximum  net  return. 
When  it  is  the  aim  of  a  monopoly  to  hold  permanent  con- 
trol of  the  supply  of  a  commodity,  it  is  necessary  to  fix 
prices  at  comparatively  low  level,  in  order  to  prevent  the 
demand  from  dwindling  away  in  the  course  of  time. 

In  order  to  gain  the  greatest  monopoly  return  with  the 
least  shrinkage  of  custom,  it  is  often  advisable  for  the 
monopolist  to  discriminate  in  prices,  burdening  heavily 
those  who  can  be  made  to  pay  high  prices,  while  levying 
moderate  charges  upon  those  who  cannot  pay  high  prices. 
In  railway  transportation,  this  practice  is  commonly  de- 
scribed under  the  name  of  "charging  what  the  traffic  will 
bear."  No  enlightened  monopoly  will  charge  prices  so  high 
as  to  handicap  its  customers  in  their  competition  with  per- 
sons not  subject  to  the  control  of  the  monopoly. 


CHAPTER   V 

THE   COST   OF   PRODUCTION 

1.  A  complete  explanation  of  prices  involves  a  statemenl 
of  the  laws  governing  the  costs  of  production. 

The  preceding  chapters  have  shown  that  the  costs  of 
production  play  an  exceedingly  important  part  in  deter- 
mining the  values  of  goods.  Commodities  produced  under 
competitive  conditions  tend  to  sell  at  cost ;  commodities 
the  production  of  which  is  controlled  by  monopolies  sell 
above  cost,  as  a  rule,  but  at  prices  which  usually  stand  in 
a  close  relation  to  the  costs  of  production.  In  practical 
life,  one  rarely  carries  the  analysis  of  value  further  than 
this.  Costs  appear  to  the  individual  producer  as  some- 
thing fairly  definite  and  fixed,  upon  which  he  may  safely 
base  his  calculations  in  deciding  whether  or  not  he  shall 
enter  a  given  line  of  business. 

From  a  business  point  of  view  the  cost  of  producing  a 
commodity  or  a  service  consists  in  the  aggregate  price  of 
the  commodities  and  services  used  up  in  the  process  of 
production.  The  greater  part  of  the  cost  of  most  com- 
modities is  made  up  of  the  price  of  materials,  the  price  of 
labor,  and  the  price  of  the  use  of  the  capital  invested  in 
plant.  These  prices  the  individual  producer  must,  as  a 
rule,  accept  as  he  finds  them,  just  as  he  accepts  the  price 
of  finished  products  as  he  finds  it.  We  have  seen  that  by 
increasing  or  reducing  the  volume  of  his  production,  the 
individual  business  man  exerts  a  real,  though  imperceptible, 
influence  upon  the  price  of  finished  products.  It  is  obvious, 
at  the  outset,  that  the  individual  business  man  must  exert 
a  like  influence  on  the  price  of  the  commodities  and  serv- 
ices' that  enter  into  his  production.  If  he  extends  his 
business,  he  must  increase  his  demand  for  labor,  machin- 

77 


78  INTRODUCTION   TO    ECONOMICS 

ery,  and  materials,  and  this  cannot  fail  to  affect  the  prices 
of  these  factors. 

2.  The  materials  of  production  Jiavc  market  and  normal 
prices  governed  by  tlie  same  laws  as  the  prices  of  finished 
products. 

We  may  examine  briefly  the  process  by  which  cotton 
yarn,  the  material  of  the  cotton-weaving  industry,  is  valued. 
A  multitude  of  weavers  desire  to  buy  it ;  some  of  them 
would  pay  a  price  of  \ox  per  hundred  pounds  rather  than 
go  without  it;  others  would  pay  only  ^x  per  hundred 
pounds.  A  multitude  of  sellers  stand  ready  to  furnish 
cotton  yarn  ;  some  may  be  wilhng  to  sell  at  5  x  rather 
than  not  sell  at  all ;  others  may  be  willing  to  sell  only  if 
the  price  is  lo.i'.  What  price  will  actually  be  set.''  Just 
as  in  the  case  of  commodities  for  direct  use,  the  market 
price  is  fixed  at  a  point  where  demand  and  supply  are 
equal  —  that  is,  where  the  amount  offered  at  a  given  price 
is  exactly  equal  to  the  amount  that  will  be  taken  at  that 
price. 

But  the  price  fixed  at  any  moment  by  demand  and  sup- 
ply may  exceed  the  cost  of  producing  the  yarn,  even  in  the 
mills  of  those  enterprisers  who  produce  at  the  greatest  cost. 
In  such  case  the  output  of  cotton  yarn  increases,  and  the 
price  falls  until  it  just  covers  cost  of  production  to  those 
who  are  producing  at  the  greatest  disadvantage.  If  the 
price  were  to  fall  still  lower,  these  producers  would  have 
to  quit  the  business;  and  this  would  reduce  supply  and 
thus  of  itself  tend  to  force  up  the  price  of  cotton  yarn. 
But  the  same  price  may  be  high  enough  to  give  excellent 
profits  to  the  more  efficient  producers;  these  continue  to  ex- 
tend their  business,  and  the  increase  in  supply  from  this 
source  may  be  more  than  an  offset  for  the  decrease  resulting 
from  the  closing  of  the  less  efficient  mills.  Thus  the  price 
gravitates  steadily  downward,  resting  momentarily  at  cost 
of  production  to  the  least  efficient  producers ;  then  sinking 


THE   COST   OF    PRODUCTION  79 

to  the  cost  level  of  slightly  more  efficient  producers;  finally 
resting  at  the  level  of  cost  of  the  most  efficient  producers 
of  all.  Thus  it  appears  that  we  need  no  new  law  to  explain 
the  action  of  buyers  and  sellers  of  cotton  yarn.  They  act 
just  as  they  would  if  they  were  buying  and  selling  a  com- 
modity ready  for  consumption. 

3.  Fhcctiiatioiis  in  the  price  of  a  product  are  reflected,  in 
greater  or  less  degree,  in  the  prices  of  materials  employed  in 
making  the  product. 

If,  through  a  general  increase  in  the  demand  for  cotton 
fabrics,  the  price  of  cotton  cloth  everywhere  rises,  all  the 
manufacturers  of  cloth  at  first  enjoy  a  profit.  To  increase 
that  profit  each  manufacturer  tries  to  extend  his  business, 
and  this  tends  to  bring  down  the  price  of  cloth.  But  in 
order  to  extend  the  cotton  cloth  manufacture,  more  yarn 
must  be  had.  The  cloth  manufacturers  are  forced  to  bid 
against  one  another  for  the  existing  supply  of  yarn,  and  the 
price  of  yarn  rises. 

We  see,  then,  that  it  is  not  merely  because  of  competi- 
tion in  the  sale  of  finished  products  that  such  products  sell 
at  cost;  it  is  also  because  of  competition  in  the  purchase 
of  the  elements  of  production.  If  the  price  of  cloth  is  for 
a  time  much  above  cost,  the  expansion  of  the  cloth  manu- 
facture tends  to  lower  the  price  of  cloth  and  raise  the  price 
of  yarn  and  other  elements  in  cost,  until  the  price  of  cloth 
and  its  cost  are  again  nearly  equal. 

Looking  now  at  the  manufacture  of  yarn,  we  see  that 
such  an  increase  in  the  price  as  we  have  assumed  will 
result  in  high  profits  throughout  the  industry,  and  conse- 
quently will  give  rise  to  an  attempt  on  the  part  of  each 
manufacturer  of  yarn  to  increase  his  output.  But  an  ex- 
pansion of  the  spinning  industry  involves  an  increase  in 
the  demand  for  raw  cotton.  Expansion  of  the  spinning 
industry  thus  tends  to  raise  the  price  of  raw  cotton  as  well 
as  to  reduce  the  price  of  yarn. 


8o  INTRODUCTION   TO    ECONOMICS 

If,  on  the  other  hand,  the  price  of  cotton  fabrics  were  to 
decHne,  we  should  see  this  decHne  reflected  in  the  price  of 
cotton  yarn,  and  later  in  the  price  of  raw  cotton.  High 
prices  of  finished  products  thus  tend  to  produce  high  costs. 
Rise  of  costs,  however,  encounters  an  opposing  tendency  in 
increased  production  of  the  goods  that  costs  represent. 

4.  The  benefits  of  an  increased  demand  for  a  finished 
product  may  rest  permanently  with  the  producers  of  the 
crudest  materials  that  enter  into  that  product. 

If  the  demand  for  steel  rises,  the  steel  manufacturer 
gains  a  profit,  in  the  first  instance.  This  benefit  is  soon 
passed  on  to  the  producer  of  pig  iron,  in  the  shape  of  a 
higher  price  for  that  product.  An  expansion  of  pig  iron 
production  follows,  and  this  entails  an  increased  demand 
and  a  higher  price  for  ore.  Thus  increased  cost  deprives 
the  pig  iron  producer  of  his  profit,  just  as  it  deprived  the 
steel  manufacturer  of  his  profit.  The  owner  of  ore  mines 
can  now  demand  a  higher  price  for  ore,  as  it  is  found  in 
the  mine.  This  ore  has,  strictly  speaking,  no  cost;  it  is  a 
free  gift  of  nature.  The  owner  of  ore  mines,  therefore, 
cannot  be  compelled  to  surrender  his  gains  to  an  ante- 
cedent producer.  So  long  as  the  increased  demand  for 
steel  exists,  he  enjoys  the  benefit  of  high  ore  prices, 
unless  better  mines  are  discovered  to  compete  with  him. 

The  relation  to  the  price  of  finished  products  of  the  price 
of  crude  materials,  as  they  exist  in  nature,  is  best  illustrated 
by  examples  drawn  from  primitive  conditions,  where  such 
materials  first  begin  to  bear  a  value.  In  a  newly  settled 
country,  the  cost  of  bricks  would  contain  no  element  rep- 
resenting clay  in  the  bank  or  trees  on  the  hillside.  It 
would  consist  solely  in  wages  of  labor  employed  in  cutting 
and  hauling  the  wood,  in  digging  and  mixing  the  clay  and 
shaping  the  bricks,  and  in  interest  on  capital  invested  in 
kilns  and  drying  sheds,  etc.  Bricks  might  at  a  given  time 
sell  at  a  price  in  excess  of  these  costs;  but  this  would  cause 


THE   COST   OF    PRODUCTION  8i 

new  brickworks  to  be  erected,  and  the  price  of  bricks  would 
fall  until  bricks  were  selling  at  a  price  merely  covering 
cost. 

As  population  increased,  the  demand  for  wood  for  brick- 
making  would  increase,  as  would  also  the  demand  for  wood 
for  other  purposes.  In  time  the  proprietor  of  woodlands 
would  see  an  end  of  the  supply  within  easy  distances, 
and  would  demand  a  price  for  wood  in  the  tree.  Here, 
then,  would  be  a  new  element  in  the  cost  of  bricks.  Further 
growth  of  population  might  make  the  supplies  of  suitable 
clay  insufificient  to  meet  all  demands,  present  and  prospec- 
tive. The  owner  of  clay  deposits  could  therefore  demand 
a  royalty  for  every  cubic  yard  of  this  material.  If  the  de- 
mand for  bricks  continued  to  increase,  the  price  of  wood 
and  of  clay  would  steadily  rise,  and  thus  a  constantly  in- 
creasing proportion  of  the  selling  price  of  the  bricks  would 
be  absorbed  by  the  cost  of  the  raw  material. 

5.  The  price  for  the  use  of  land,  suitable  for  one  product 
only,  fluctuates  with  changes  in  the  demand  for  its  product. 

In  some  of  the  countries  of  North  Europe  are  found 
extensive  tide-marshes  noted  for  the  production  of  exceed- 
ingly nutritious  grasses.  These  lands  cannot,  without 
great  expense,  be  put  to  any  other  use  than  that  of  pro- 
ducing forage.  When  the  price  of  dairy  products  rises, 
the  rental  of  these  lands  rises ;  when  the  competition  of 
inland  districts  forces  down  the  price  of  dairy  products, 
the  rental  declines.  Owing  to  the  influence  of  custom  in 
maintaining  ground  rents  at  a  fairly  stationary  level,  the 
rental  of  such  lands  is  likely  to  rise  only  after  the  higher 
level  of  dairy  products  has  been  established  for  a  con- 
siderable period.  But  in  time  the  value  of  the  final  prod- 
uct is  inevitably  reflected  in  the  rental  of  the  land. 

In  most  cases  land  may  be  put  to  a  variety  of  uses. 
Corn  land  may  be  put  under  grass,  fruit,  or  vegetables. 
The  rental  of  corn  land  cannot  fall  below  the   probable 


82  INTRODUCTION   TO    ECONOMICS 

rental  that  the  land  would  yield  under  other  crops.  But 
often  land  is  so  peculiarly  suited,  by  quality  or  by  situa- 
tion, for  the  production  of  a  specific  crop  that  the  price 
of  its  use  comes  to  depend  upon  that  one  crop  alone. 

Let  us  suppose  that  a  beet  sugar  manufactory  is  estab- 
lished somewhere  in  the  heart  of  the  wheat  belt.  Natu- 
rally, if  a  farmer  wishes  to  rent  a  field  upon  which  to  grow 
sugar  beets,  he  will  have  to  pay  as  high  a  rental  as  wheat 
growers  in  the  vicinity  pay  for  the  same  quality  of  land. 

Beet  growers  may  find,  after  paying  all  other  costs,  that 
a  considerable  profit  remains  in  their  hands  from  the  sale 
of  their  beets.  In  such  case  this  form  of  culture  will 
expand,  and  more  and  more  wheat  land  will  be  devoted 
to  the  growing  of  beets.  The  increasing  output  of  beets 
may  conceivably  reduce  their  price ;  but  more  probably, 
since  an  enormous  increase  in  the  sugar  output  of  a  given 
locality  is  yet  a  very  small  addition  to  the  world's  sugar 
supply,  the  price  of  beets  will  remain  fairly  constant. 
Accordingly,  the  expansion  of  the  industry  will  continue 
until  all  the  good  lands  within  a  reasonable  distance  from 
the  factory  are  given  over  to  this  branch  of  agriculture. 
If  the  beet  growers  still  have  a  surplus  profit,  they  will 
compete  among  themselves  for  land,  each  desiring  to  in- 
crease his  acreage.  Higher  rents  will  be  offered,  until 
the  extra  profits  of  the  enterpriser  are  absorbed  by  this 
increasing  element  in  cost.  If  for  any  reason  the  price 
of  sugar  rises  to  a  higher  level,  the  rental  of  beet  lands 
must  also  rise. 

6.  Under  certain  conditions  the  wages  of  labor  are  inti- 
mately connected  with  the  price  of  a  particular  product. 

Let  us  imagine  that  a  new  branch  of  production  arises 
—  say,  the  manufacture  of  wrapping  paper  from  corn- 
stalks. A  single  factory  is  erected,  and  let  us  assume  that 
it  will  be  operated  in  the  winter  months  only.  The  fac- 
tory we  may  suppose  is  established  in  the  country,  near 


THE    COST    OF    PRODUCTION  83 

the  source  of  raw  material.  And  in  the  country  there  is  a 
great  deal  of  labor  that  is  not  employed  in  the  winter 
months.  At  what  rate  will  our  manufacturer  be  able  to 
hire  this  labor .'' 

It  is  clear  that  the  cost  of  living  will  have  nothing  to  do 
with  the  wages  fixed.  Country  laborers  are  paid  enough 
in  the  open  months  of  the  year  to  carry  them  through  the 
winter.  What  they  earn  in  the  paper  factory  is  a  net  addi- 
tion to  their  annual  income.  They  can  work  for  nothing, 
and  be  no  poorer  than  they  were  before  the  factory  was 
erected.  The  work  in  the  factory  may  be  pleasant  rather 
than  otherwise.  Nevertheless,  it  is  safe  to  assume  that 
some  rate  of  wages  must  be  paid.  Perhaps  a  wage  of 
fifty  cents  a  day  will  provide  the  requisite  amount  of  labor. 
If  so,  that  is  all  the  manufacturer  will  pay. 

Now,  if  the  manufacturer  gets  his  labor  at  such  a  low 
rate,  he  may  make  extraordinarily  high  profits.  In  this 
case  other  enterprisers  are  likely  to  go  into  the  business. 
If  the  industry  assumes  extensive  proportions,  it  soon 
drains  off  the  supply  of  labor  that  can  be  had  for  fifty 
cents  a  day.  Further  expansion  becomes  possible  only 
through  an  increase  in  wages  which  will  tempt  into  the 
industry  workmen  who  regard  their  ease  as  worth  more 
than  fifty  cents  a  day,  or  who  are  earning  at  least  that 
wage  in  caring  for  live-stock,  etc.  But  profits  may  still 
be  high,  and  new  enterprisers  may  be  continually  enter- 
ing, the  business.  To  secure  laborers  they  are  compelled 
to  offer  wages  slightly  higher  than  those  paid  by  the 
enterprisers  whose  business  is  already  established.  The 
latter,  in  order  to  retain  their  laborers,  are  compelled 
to  meet  the  bids  of  their  new  competitors.  Thus  wages 
for  this  kind  of  work  go  up,  until  all  the  enterprisers  are 
fully  supplied  with  workmen. 

Any  further  expansion  will  be  followed  by  a  similar  in- 
crease in  competition  among  employers  of  labor,  and  a  rise 


84  INTRODUCTION   TO   ECONOMICS 

in  the  rate  of  wages  will  be  necessary  in  order  to  induce 
less  industrious  workers,  or  workers  having  some  alterna- 
tive employment,  to  enter  the  factories.  But  each  expan- 
sion of  the  industry  means  an  increased  product  thrown 
on  the  market,  and,  other  things  equal,  a  lower  price  for 
it.  What  with  the  rising  of  wages  and  the  falling  price  of 
paper,  it  is  clear  that  the  profits  of  the  enterpriser  must 
decline.  Possibly  the  expansion  will  continue  until  wages 
have  risen  to  $2.  All  depends  upon  the  amount  of  paper 
that  will  be  taken  at  a  given  price,  and  the  amount  of 
labor  available. 

7.  T/ie  price  of  labor  depc}ids  pot  only  on  the  price  of  the 
finished  product,  but  also  on  the  price  of  other  factors  in 
production. 

Let  us  assume  that  there  is  a  city  which  has  been 
devoted  almost  exclusively  to  the  manufacture  of  iron 
and  steel  goods.  A  cotton  manufacturer,  visiting  the  city 
—  Ironton,  let  us  call  it  —  shrewdly  concludes  that  the 
iron  workers  must  have  a  number  of  sisters  and  daughters 
and  other  female  relatives,  who  are  practically  wasting 
their  time,  and  who  would  be  glad  to  earn  a  small  income 
by  cotton  spinning  and  weaving.  Accordingly  he  erects  a 
mill  at  Ironton.  Very  likely  he  will  get  all  the  labor  he 
cares  for  at  twenty-five  cents  a  day,  while  his  competitors, 
in  the  established  centers  of  the  trade,  are  paying  a  dollar 
a  day  for  the  same  grade  of  labor.  In  this  case  the  cost 
of  producing  a  given  grade  of  cottons  at  Ironton  may  be 
twenty  per  cent  lower  than  the  cost  of  producing  the  same 
grade  in  the  older  centers,  while  the  seUing  price  must  be 
about  the  same  since  cottons  are  easily  transported  from 
one  center  to  another.  Of  course  this  will  give  the  enter- 
priser at  Ironton  large  profits.  Before  long  other  enter- 
prisers will  begin  to  inquire  why  a  cotton  mill  has  been  set 
up  at  Ironton  ;  and  finding  what  advantages  that  city  offers 
in  the  way  of  low  costs,  they  too  will  erect  mills  there. 


THE   COST   OF   PRODUCTION  85 

The  effect  of  the  appearance  of  these  new  manufac- 
turers at  fronton  is  to  increase  the  demand  for  cheap 
labor.  Possibly  there  are  so  many  women  and  girls  who 
are  ready  to  work  for  "  pin  money  "  that  the  new  mills  can 
be  plentifully  suppUed  with  labor  at  the  same  price  that  has 
been  paid  by  the  enterpriser  first  in  the  field.  But  it  can- 
not be  a  great  while  before  the  supply  of  twenty-five-cent 
labor  falls  short  of  the  demand  ;  enterprisers  erecting  new 
mills  will  have  to  offer  slightly  higher  wages  to  entice 
workers  away  from  the  older  mills,  and  these  will  have 
to  raise  wages  to  the  rate  offered  by  the  newcomers.  The 
competition  will  continue  until  wages  are  so  high  as  to 
induce  a  new  set  of  workers  to  enter  the  mills.  Costs  at 
Ironton  may  still  be  abnormally  low  after  wages  have 
risen,  say,  to  fifty  cents  a  day.  In  that  case  the  cotton 
industry  at  Ironton  will  go  on  expanding,  until  at  last 
aefofresrate  costs  are  as  great  at  Ironton  as  in  the  older 
centers  of  the  trade. 

The  point  that  here  needs  emphasis  is  that  the  com- 
petition of  different  centers  equahzes,  not  wages  cost,  but 
aggregate  costs.  Coal  may  be  cheaper  at  Ironton  than  in 
other  centers  of  the  industry;  mechanics'  services  in  the 
erection  of  buildings  and  in  the  setting  up  and  repair  of 
machinery* may  also  be  cheaper.  In  such  case  cotton 
manufacturers  at  Ironton  are  not  producing  at  cost  even 
when  the  wages  of  textile  laborers  are  as  high  as  in  other 
centers.  There  still  remains  a  margin  of  profit,  which 
leads-  to  expansion  of  the  industry  and  increased  demand 
for  labor.  Under  competition  wages  at  Ironton  must 
inevitably  rise  above  the  average  in  other  centers.  We 
may,  therefore,  formulate  the  principle  that  if  competition 
exists  among  different  producing  centers,  all  supplying  the 
same  markets,  wages  in  an  industry  in  one  center  will  rise 
or  fall  until,  together  with  other  costs  of  production,  they 
equal  wages  plus  other  costs  of  production  in  the  other 


86  INTRODUCTION   TO   ECONOMICS 

centers  where  the  industry  is  carried  on.  To  give  a 
numerical  example :  if  in  city  A  one  hundred  yards  of 
cotton  cloth  cost  ^lo,  of  which  $8  consists  of  cost  of 
materials,  fuel,  interest  on  capital,  etc.,  and  $2  of  wages; 
and  if  in  city  B,  which  obtains  the  same  price  for  cloth  at 
the  mill,  all  other  costs  amount  to  only  $y,  wages  in  B  will 
rise,  under  competition,  until  labor  cost  amounts  to  $3. 

Much  attention  has  been  given  to  the  fact  that  in  many 
branches  of  industry  the  American  producer  can  meet  the 
competition  of  the  foreign  producer,  although  the  former 
pays  higher  wages  than  the  latter.  In  many  cases  the 
personal  efficiency  of  the  American  laborer  is  so  much 
greater  than  that  of  the  foreign  laborer  that  wages  cost, 
per  unit  of  product,  is  less  in  this  country  than  in  foreign 
countries.  Wages  cost  is  thus  higher  only  in  appearance, 
not  in  reality.  In  other  cases  the  low  prices  at  which 
Americans  can  afford  to  sell  are  to  be  explained  by  the 
exceptionally  low  prices  prevailing  here  for  other  cost 
factors  —  fuel,  the  use  of  land,  etc. 

8.  T/ic  dependence  of  the  price  of  cost  goods  upon  the 
price  of  finisJicd  products  is  iisually  obscjired  by  the  fact 
that  most  cost  goods  are  demanded  by  more  tJian  one 
industry. 

In  a  large  area  of  the  Northwest,  the  soil  is  equally  well 
adapted  for  the  growing  of  corn  and  of  wheat.  If  the  price 
of  wheat  falls,  the  rent  on  land  formerly  used  for  wheat 
growing  will  not  necessarily  decline.  The  land  will  simply 
be  taken  over  by  corn  culture,  and  continue  to  yield  the 
same  rent.  Here  it  appears  that  the  necessity  of  paying 
rent  exerts  a  controlling  influence  on  the  supply  of  wheat, 
and  hence  on  its  price.  The  labor  which  can  be  used  in 
farming  can  also  be  used  for  railway  building  and  for  much 
of  the  unskilled  work  in  the  cities.  If,  then,  the  prices  of 
farm  products  decline,  the  wages  of  farm  labor  may  de- 
cline only  slightly,  if  at  all,  since  any  reduction  in  wages 


THE   COST   OF    PRODUCTION  87 

would  drive  laborers  into  other  employments.  In  any  single 
industry,  the  price  of  labor  and  of  other  cost  goods  is  likely 
to  be  less  subject  to  the  control  of  the  men  engaged  in  the 
industry  than  is  the  price  of  the  products  of  the  industry. 
To  double  the  output  of  a  particular  grade  of  cotton  cloth 
would,  under  ordinary  circumstances,  reduce  its  price  very 
materially.  The  expansion  of  the  production  of  this  grade 
of  cloth  would  represent  an  increased  demand  upon  the 
supply  of  raw  material,  of  labor,  and  of  fuel.  But  this  in- 
crease might  represent  less  than  one  ten-thousandth  of  the 
total  demand  for  these  factors  in  production,  and  would 
consequently  exert  scarcely  a  perceptible  influence  upon 
their  price.  It  is  natural,  then,  that  practical  men  should 
regard  costs  as  something  fixed  and  independent  of  their 
control,  while  they  regard  the  price  of  finished  products 
as  variable  and  dependent  upon  their  action  in  producing 
or  refraining  from  production. 

9.  llVie/r  tzvo  centers  of  production  compete  freely  zvitJi 
each  other,  the  one  may  be  able  to  drive  the  other  out  of  cer- 
tain lines  of  industry.  One  cannot  drive  the  other  out  of  all 
lines  of  industry. 

It  is  often  said  that  the  South  can  manufacture  cotton 
more  cheaply  than  New  England,  and  that  therefore,  since 
both  sections  must  sell  their  products  at  practically  the 
same  price,  cotton  manufacture  in  New  England  is  doomed. 
The  advantages  of  the  South  are  said  to  be  cheaper  labor 
and  cheaper  power.  Let  us  see  how  long  these  advan- 
tages can  be  retained. 

As  the  South  extends  its  production,  the  price  of  cotton 
goods  declines.  Possibly  some  New  England  mills  are 
forced  to  shut  down  ;  others,  while  continuing  in  operation, 
reduce  their  output.  The  expansion  of  the  industry  in  the 
South  increases  the  demand  for  labor  and  tends  to  raise  its 
price.  The  contraction  of  the  industry  in  New  England 
reduces  the  demand  for  labor,  and  tends  to  lower  its  price. 


88  INTRODUCTION   TO   ECONOMICS 

Forces  are  therefore  at  work  reducing  the  difference  be 
tvveen  the  two  centers  in  labor  cost. 

But  the  wages  of  cotton  operatives  depend  not  only 
on  the  fortunes  of  the  cotton  industry,  but  on  the  fortunes 
of  other  industries  as  well.  A  reduction  in  the  wages  of 
cotton  mill  hands  in  New  England  causes  an  efflux  of 
such  labor  into  other  industries,  and  this  tends  to  check 
the  reduction  in  wages.  In  the  South  rising  wages  in  the 
cotton  industry  is  followed  by  an  influx  of  laborers  from 
other  industries,  and  this  tends  to  check  the  rise  of  wages. 
It  is  quite  possible  that,  owing  to  the  existence  of  other 
industries  capable  of  absorbing  labor  on  the  one  hand, 
or  of  yielding  up  labor  on  the  other,  the  South  will  get  a 
larger  and  larger  share  of  the  cotton  industry,  until  it 
has  taken  over  practically  the  whole  business. 

Now  let  us  suppose  that  all  the  industries  of  the  South  are 
in  competition  with  all  the  industries  of  New  England,  and 
that  costs  are  lower  in  the  former  part  of  the  country  than 
in  the  latter.  An  attempt  on  the  part  of  all  Southern 
producers  to  extend  their  outputs  immediately  forces  up  the 
price  of  all  producers'  goods  —  labor,  fuel,  and  water  power, 
etc.  A  tendency  on  the  part  of  all  New  England  producers  to 
restrict  production  immediately  reduces  the  price  of  pro- 
ducers' goods.  It  is,  then,  only  for  a  brief  time  that  all 
costs  can  be  higher  in  one  section  than  in  the  other.  The 
higher  price  of  labor  might  indeed  induce  the  whole  New 
England  working  population  to  migrate  to  the  South  ;  but 
in  no  other  possible  way  could  the  volume  of  New  England 
industry  be  permanently  restricted  by  Southern  competition. 

The  same  reasoning  applies  to  international  competition. 
It  is  folly  to  talk  of  the  probability  that  British  industry 
will  be  driven  to  the  wall  by  German  and  American  com- 
petition. Wages  and  interest  in  Great  Britain  may  be 
reduced  by  foreign  competition,  and  this  may  induce  men 
and  capital  to  emigrate.     This  would  reduce  the  volume  of 


THE   COST   OF   PRODUCTION  8g 

British  production,  but  it  is  impossible  that  the  British  man- 
ufacturer would  in  the  long  run  find  prices  too  low  to  cover 
costs.  The  latter  adjust  themselves  to  prices,  and  fall  when 
general  prices  fall. 

10.  Some  costs  uuDiifest  a  more  direct  depcndcucc  on  the 
price  of  particular  finished  products  than  do  others.  The 
former  are  tJierefore  said  to  be  price-determined ;  the  latter 
are  said  to  be  price-determining. 

In  the  making  of  bricks,  the  laborers  employed  are  for 
the  most  part  of  a  kind  equally  well  suited  for  farm  labor 
or  for  unskilled  labor  in  the  cities.  The  fuel  used  in 
burning  the  bricks  might  be  put  to  a  hundred  other  uses. 
The  clay,  on  the  other  hand,  can  probably  be  used  for 
nothing  but  for  making  bricks. 

Accordingly,  if  the  price  of  bricks  rises,  this  can  hardly 
affect  the  price  of  labor  or  of  fuel.  For  the  price  of  these 
goods  is  derived  from  a  wide  range  of  production  in  which 
they  are  employed,  and  the  making  of  bricks  represents  a 
neghgible  part  of  the  demand  for  them.  It  is  entirely 
different  with  the  price  of  clay.  If  the  available  deposits 
are  limited,  this  price  may  rise  so  high  as  to  absorb  prac- 
tically the  entire  gains  resulting  from  the  rise  in  the  price 
of  bricks.  If  the  price  of  bricks  falls,  the  loss  is  borne 
chiefly  by  the  owner  of  the  clay  deposit. 

In  a  country  whose  agriculture  consists  almost  exclu- 
sively in  wheat  raising,  a  rise  in  the  price  of  wheat  will 
raise  wages  of  farm  hands  only  slightly,  as  the  rate  of 
wages  in  agriculture  must  bear  a  close  relation  to  the  rate 
of  wages  in  other  unskilled  pursuits.  It  will  raise  the  rent 
of  wheat  lands,  as  the  price  of  the  use  of  such  lands  de- 
pends on  their  use  for  growing  wheat,  and  on  nothing  else. 
It  is  easy,  therefore,  to  see  what  the  earlier  economists 
meant  when  they  said  that  rent  is  the  effect,  not  the  cause, 
of  price.  Rents,  under  certain  conditions,  rise  or  fall  with 
the  price  of  agricultural  produce.     Certain  modern  econo- 


90  INTRODUCTION   TO   ECONOMICS 

mists  express  the  same  thought  when  they  say  that  rents 
are  price-determined.  Wages  were  regarded  by  earliei 
economists  as  the  cause,  not  the  effect,  of  price ;  they  are 
said  by  some  modern  economists  to  be  price-determining, 
not  price-determined.  As  we  have  seen  in  the  foregoing 
sections,  a  sufficiently  broad  view  shows  that  the  prices  of 
all  cost  goods  are  derived  from  the  prices  of  their  products. 
And  there  are  few  cost  goods  so  definitely  restricted  to  a 
particular  line  of  production  that  a  reduction  in  their  price 
in  one  industry  does  not  result  in  a  partial  withdrawal  of 
their  supply,  with  a  consequent  reaction  on  price. 

11.    Summary. 

Since  prices  normally  bear  a  close  relation  to  the  costs 
of  production,  an  ultimate  explanation  of  prices  involves 
an  explanation  of  the  forces  determining  costs.  The 
general  principle  is  that  the  prices  of  cost  goods  are  de- 
rived from  the  prices  of  finished  products.  Accordingly, 
when  the  price  of  a  finished  product  rises,  this  rise  is  re- 
flected first  in  the  prices  of  those  goods  that  enter  into  its 
production,  and  later  in  the  prices  of  goods  entering  into 
the  production  of  the  cost  goods.  Under  competition  the 
benefits  from  a  rise  in  the  price  of  a  finished  commodity 
rest  ultimately  with  the  factors  in  production  that  are 
limited  in  quantity,  either  by  natural  or  by  social-economic 
conditions. 

If  a  production  good  is  used  in  a  large  number  of  indus- 
tries, a  rise  or  fall  in  the  price  of  any  single  commodity 
into  which  it  enters  will  have  little  effect  upon  its  price. 
For  to  reduce  the  price  of  the  production  good  in  one  indus- 
try would  result  in  diverting  it  to  other  industries.  A  condi- 
tion of  producing  a  finished  commodity  is  a  price  sufficient  to 
pay  the  usual  rate  for  production  goods  of  this  kind.  Such 
goods  are  therefore  in  a  price-determining  position.  The 
production  goods  which  can  be  used  in  only  one  industry 
rise  or  fall  in  price  with  the  products  of  that  industry. 


CHAPTER   VI 

THE   LAW   OF   DIMINISHING   RETURNS 

1.  Increase  in  the  outpjit  of  an  industry  is  normally  checked 
by  increase  in  the  cost  of  some  factor  in  production,  due  to  the 
difficulty  oicotijitered  in  increasing  the  supply  of  that  factor. 

In  the  last  chapter  we  saw  that  one  of  the  forces  limiting 
the  expansion  of  an  industry  is  the  tendency  of  costs  to 
rise  to  the  selHng  price  of  the  product  of  the  industry.  The 
American  cotton-spinning  industry  may  be  very  profitable 
this  year  —  that  is,  the  margin  between  the  selling  price  of 
cotton  yarn  and  the  cost  of  producing  it  may  be  wide.  But 
before  long  an  expansion  of  the  industry  will  take  place ; 
increasing  demands  upon  the  existing  supply  of  skilled 
labor,  of  raw  cotton,  and  of  other  factors  in  the  production- 
of  cotton  yarn  will  force  the  expenses  of  the  enterprisers 
engaged  in  the  industry  to  a  higher  level. 

We  saw  further  that  not  all  elements  in  cost  show  the 
same  tendency  to  increase.  In  cotton  spinning,  part  of  the 
labor  force  is  skilled,  part  of  it  unskilled.  If  the  industry 
were  to  expand,  say,  by  fifty  per  cent,  a  great  strain  would 
be  put  upon  the  supply  of  labor  specially  trained  for  cotton 
spinning.  No  perceptible  strain  would  be  placed  upon  the 
supply  of  unskilled  labor,  for  outside  of  the  spinning  indus- 
try enormous  quantities  of  unskilled  labor  are  to  be  had. 
The  skilled  labor  might  therefore  for  a  time  enjoy  a  large 
increase  in  wages,  while  the  wages  of  unskilled  labor  would 
scarcely  be  affected  at  all. 

Similarly,  such  an  expansion  of  the  industry  would 
represent  a  great  strain  upon  the  supply  of  raw  cotton, 
which  for  a  year  could  not  be  increased.  Quite  possibly 
the  price  of  raw  cotton    would  be    doubled.      The    same 

91 


92 


INTRODUCTION    TO    ECONOMICS 


expansion  of  the  cotton-spinning  industry  would  result  in 
an  increased  demand  for  coal  for  power.  But  the  use  of 
coal  is  so  universal,  and  the  volume  of  its  consumption  so 
vast,  that  the  increased  demand  from  the  cotton  industry- 
would  be  a  negligible  factor  in  influencing  its  price.  Coal 
would  probably  not  rise  perceptibly. 

2.    TJie    individual    enterpriser    usically    finds    himself 
hampered  in  his  efforts  to  increase  his  business  by  the  dif- 
ficulty of  increasing  his  supply  of  some  of  the  factors  entering 
into  his  production. 

For  a  somewhat  different  reason,  the  output  of  a  single 
enterpriser  can  often  be  increased  only  at  increasing  cost. 
It  is  true  that  one  enterpriser  out  of  a  multitude  cannot 
force  up  the  wages  of  labor  against  himself,  as  a  whole  in- 
dustry can  do.  Nor  can  he  exert  any  perceptible  influence 
upon  the  price  of  raw  material  and  other  supplies.  But 
there  are  usually  certain  factors  entering  into  his  produc- 
•tion  that,  so  far  as  he  is  concerned,  are  either  limited  abso- 
lutely, or  can  be  increased  only  at  a  disproportionately 
heavy  outlay.  In  any  agricultural  section  you  may  find  an 
enterprising  farmer  forced  to  limit  his  operations  to  a  single 
hundred  acres.  He  can  hire  as  many  men  as  he  pleases  at- 
$25  a  month,  the  price  he  pays  his  one  "hired  hand."  He 
can  buy  additional  teams  and  additional  machinery  at  no 
advance  over  the  price  of  those  he  already  has.  Why 
docs  he  not  buy  or  rent  additional  land,  and  carry  on  a 
large  scale  business  .-*  Because  all  the  adjoining  lands  are 
occupied  by  men  who  prefer  to  till  them  with  their  own 
labor  and  who  would  consequently  demand  a  very  high 
rental,  if  they  consented  to  give  up  their  land.  Our  farmer 
might  be  compelled  to  go  a  distance  of  three  or  four  miles 
to  get  additional  land  at  reasonable  rates.  Of  course  land 
cannot  be  advantageously  cultivated  from  such  a  distance. 
Hence  he  is  forced  to  content  himself  with  his  own  one 
hundred  acres. 


THE   LAW    OF    DIMINISHING    RETURNS  93 

In  almost  any  town  you  may  find  a  bright  and  capable 
young  grocer,  conducting  the  pettiest  corner  grocery  busi- 
ness. The  possibilities  of  trade  may  be  numerous;  a  store 
ten  times  as  large  might  easily  be  supported  by  the  potential 
custom.  Why  then  do  we  find  a  little  store .''  The  young 
merchant  might  easily  rent  larger  premises,  without  more 
than  a  proportionate  increase  in  rent.  He  might  hire  as 
many  clerks  and  delivery  boys  as  he  wished,  without  pay- 
ing a  rate  of  wages  in  excess  of  the  rate  he  pays  to  the 
one  or  two  already  in  his  employ.  What  he  especially 
lacks  is  capital.  Perhaps  he  has  $5000  of  his  own.  The 
cost  which  the  use  of  this  capital  represents  is  merely  the 
interest  he  could  get  at  a  savings  bank  —  say,  four  per  cent. 
With  $5000  capital  of  his  own,  he  may  be  able  to  borrow 
another  ^5000  at  six  per  cent.  For  an  additional  $5000 
he  would  probably  have  to  pay  ten  per  cent,  as  the  security 
he  has  to  offer  is  not  so  good.  It  is  luilikely  that  he  can 
borrow  more  capital,  no  matter  how  high  a  rate  of  interest 
he  may  be  willing  to  pay.  The  maximum  business  he  can 
conduct,  then,  is  one  for  which  a  capital  of  $15,000  will 
sufifice. 

A  small  stream,  flowing  between  high,  rocky  banks, 
may  offer  an  excellent  opportunity  for  the  establishment  of 
a  factory  to  be  operated  by  water  power.  Let  us  suppose 
that  a  manufacturer,  acquainted  with  the  advantages  of  the 
location,  decides  to  erect  a  mill.  He  may  be  able  to  com- 
mand practically  unlimited  capital.  Whether  his  mill  will 
require  one  hundred  hands  or  one  thousand  will  make  no 
difference  in  the  rate  of  wages  he  will  have  to  pay.  Raw 
material  can  be  obtained  at  least  as  cheaply  in  large  lots  as 
in  small.  Plainly,  what  will  determine  the  size  of  the  fac- 
tory will  be  the  power  to  be  obtained  from  the  stream.  A 
ten-foot  dam  will  give  a  certain  power ;  a  twenty-foot  dam 
a  much  greater  one,  and  every  additional  foot  in  height  of 
dam  means  additional  power.     But  there  is  an  absolute  limit 


94 


INTRODUCTION   TO    ECONOMICS 


to  the  height  to  which  the  dam  may  reach,  without  forcing 
the  stream  above  its  banks  and  ruining  a  large  amount  of 
property  on  the  lower  levels  adjacent  to  it.  There  may  also 
be  limits  of  expense  ;  after  the  dam  has  reached  a  height 
of  twenty  feet,  further  addition  to  its  height  may  imply  such 
a  great  increase  in  its  length  and  in  the  character  of  the 
materials  required  to  stand  the  increased  strain  that  the 
additional  power  is  not  worth  its  cost. 

It  will  not  be  necessary  to  multiply  instances  further. 
If  the  reader  will  examine  the  various  businesses  with 
which  he  is  acquainted,  he  will  observe  that  in  a  large  pro- 
portion of  them  it  is  difficult,  if  not  impossible,  to  duplicate 
all  the  elements  in  production  without  incurring  dispropor- 
tionate expense. 

3.  /;/  some  cases  an  absolute  limit  is  placed  upon  produc- 
tion zvhen  one  of  the  factors  cannot  be  increased  iji  amount. 
In  most  cases,  by  the  application  of  increased  amounts  of  the 
other  factors,  pi'oduction  may  be  increased,  but  with  con- 
stantly greater  difficulty. 

Among  the  products  of  industry  are  many  chemical 
compounds,  the  components  of  which  are  combined  in 
perfectly  definite  proportions.  A  shortage  of  fifty  per 
cent  in  the  supply  of  any  component  entails  a  shortage  of 
fifty  per  cent  in  the  finished  product.  In  most  cases, 
however,  the  producer  can  vary  the  proportions  in  which 
economic  elements  in  production  are  combined.  A 
bushel  of  wheat  may  be  produced  on  a  relatively  large 
area  with  the  application  of  a  small  amount  of  labor,  or 
on  a  relatively  small  area  with  the  application  of  a  large 
amount  of  labor.  Cotton  cloth  may  be  woven  with  rela- 
tively small  expenditure  of  labor  and  large  expenditure 
of  power,  or  with  large  expenditure  of  labor  and  small 
expenditure  of  power.  Even  a  slight  acquaintance  with 
actual  business  conditions  gives  ample  illustration  of 
the  fact  that  in  every  industry  there  is  great  variety  in 


THE   LAW   OF   DIMINISHING   RETURNS  95 

the  proportions  in  which  the  various  producing  factors  are 
combined.  Accordingly,  if  a  business  man  is  confined  to 
a  limited  supply  of  one  factor,  he  may  yet  increase  his 
operations  by  selecting  a  method  which  involves  small  use 
of  the  limited  factor  and  large  use  of  the  other  factors. 

4.  Au  increase  in  tJie  amount  of  labor  and  auxiliary  capi- 
tal employed  upon  a  given  area  of  land  does  'not,  as  a  rule, 
resjilt  in  proportionate  increase  in  product. 

Let  us  return  now  to  the  case  of  the  farmer,  confined  to 
his  one  hundred  acres  of  tillable  land.  By  his  own  labor 
and  with  a  single  team  and  the  appropriate  machinery  he 
may  till  the  whole  tract.  Fifty  acres,  we  may  imagine,  are 
put  into  wheat,  fifty  acres  into  corn.  In  the  time  for  sow- 
ing wheat,  a  few  good  days  may  be  followed  by  a  week  of 
rainy  weather.  Half  of  the  wheat  field  may  be  sowed  in 
time  to  get  the  benefit  of  the  wet  weather ;  the  other  half 
of  the  field  may  have  to  be  left  until  the  ground  is  dry, 
and  so  this  part  of  the  crop  will  lose  the  advantage  of  an 
early  start.  Similarly,  part  of  the  corn  planting  may  be 
belated,  with  resultant  danger  to  the  crop  from  early  frosts. 
There  may  not  be  enough  dry  days  in  the  late  spring  to 
enable  the  farmer  to  keep  his  cornfield  free  from  weeds. 
In  harvest  time,  the  chances  of  loss  from  delays  in  cutting 
and  stacking  the  wheat  are  still  greater.  Of  course  these 
adverse  chances  may  not  be  realized.  The  weather  may 
be  dry  just  when  it  should  be;  the  rains  may  come  just 
when  they  are  wanted.  But  experience  proves  that  the 
weather  is  not  thus  happily  regulated.  One  year  with 
another,  our  farmer  will  be  fortunate  if  he  gets  twelve 
bushels  of  wheat  and  forty  bushels  of  corn  per  acre. 

Instead  of  tilling  the  whole  tract  with  his  own  labor, 
the  farmer  may  hire  a  man  to  help  him.  He  buys  an 
additional  team,  plow,  harrow,  cultivator,  etc.,  practically 
duplicating  his  stock  of  machinery  as  well  as  his  supply  of 
labor.     The  land  can  now  be  much  more  carefully  tilled; 


96  INTRODUCTION   TO   ECONOMICS 

it  will  almost  surely  yield  a  greater  aggregate  return. 
Will  the  return  be  doubled  ?  It  would  be  unreasonable  to 
expect  this.  More  probably,  the  wheat  yield  will  increase 
to  fifteen  bushels ;  the  corn  yield,  to  fifty  bushels. 

Now  let  us  imagine  that  the  farmer  employs  a  second 
hired  laborer,  and  invests  an  additional  $500  in  a  team  and 
machinery.  How  much  will  be  added  to  the  crop  .-*  It  is 
unlikely  that  the  addition  will  be  as  great  as  that  resulting 
from  the  employment  of  the  first  hired  workman.  We 
will  assume  that  the  wheat  crop  per  acre  is  increased  to 
seventeen  bushels,  the  corn  crop  to  fifty-live.  With  a  third 
hand  the  crop  of  wheat  would  perhaps  increase  to  eighteen 
bushels,  and  the  crop  of  corn  to  fifty-eight.  A  fourth 
hand  might  increase  the  crop  of  wheat  to  eighteen  and 
one-half  bushels  ;  that  of  corn,  to  fifty-nine  bushels.  There 
is  no  reason  why  every  additional  workman  should  not 
make  some  small  addition  to  the  crop,  until  the  wheat  crop 
had  become  fifty  bushels  and  the  corn  crop  one  hundred 
and  fifty. 

An  important  principle,  involved  in  this  example,  may 
now  be  stated.  From  a  given  area  of  ground,  an  amount 
of  produce  can  be  obtained  increasing  with  every  increase 
in  the  labor  and  auxiliary  capital  employed  in  tillage,  but 
increasing  less  than  proportionally  with  the  increase  in 
labor  and  auxiliary  capital.  This  principle  is  called  the 
law  of  dimhiisJiing  returns  in  agriculture. 

5.  Returns  diminish  more  rapidly  in  some  branches  of 
agriculture  than  in  other  branches. 

Some  crops  are  far  more  responsive  to  the  efforts  of  the 
husbandman  than  are  others.  If  a  wheat  field  is  well  fer- 
tilized and  properly  prepared  to  receive  the  seed,  it  may 
yield  twenty  bushels  per  acre.  An  American  farmer  would 
find  it  next  to  impossible  to  raise  the  yield  to  forty  bushels, 
even  at  the  expenditure  of  almost  unlimited  pains.  A 
similar  field,  prepared  in  the  ordinary  manner,  may  yield 


THE   LAW   OF    DIMINISHING   RETURNS  97 

fifty  bushels  of  potatoes  per  acre.  By  extreme  care  in 
selecting  the  seed  and  in  keeping  the  field  free  from  weeds 
and  from  insects  the  yield  might  possibly  be  raised  to  two 
hundred  bushels,  or  even  much  more.  It  is  more  feasible 
to  quadruple  the  potato  crop  than  to  double  the  wheat 
crop.  In  the  production  of  many  garden  vegetables  and 
small  fruits,  the  returns  to  extraordinary  care  are  often 
alrnost  incredible.  Indeed,  it  has  sometimes  even  been 
doubted  whether  the  law  of  diminishing  returns  is  oper- 
ative in  the  growing  of  such  products.  There  can  be  no 
doubt  that  doubling  the  amount  of  labor  expended  upon  a 
given  area  in  gardening  often  increases  the  output  by  more 
than  one  hundred  per  cent.  But  it  is  self-evident  that  a 
point  must  eventually  be  reached  where  a  doubling  of  the 
expenditure  for  labor  will  fail  to  double  the  output. 

6.  If  the  amount  of  capital  expended  in  improving  a  given 
urban  building  site  is  increased,  the  returns  do  not  increase 
proportionately  tvith  the  increase  in  capital. 

The  principle  of  diminishing  returns,  as  it  operates  in 
agriculture,  was  first  formulated  by  economists  more  than 
a  hundred  years  ago,  although  practical  men  have,  of 
course,  taken  account  of  it  in  their  business  conduct  ever 
since  agriculture  became  man's  chief  source  of  food.  The 
applicability  of  the  principle  to  land  devoted  to  trading  and 
manufacturing  purposes  was  for  a  long  time  ignored  by 
economists.  This  may  be  explained  by  the  fact  that 
formerly  urban  land  was  so  cheap  that  the  small  amount 
required  for  the  erection  of  a  shop  or  a  factory  represented 
an  almost  negligible  element  in  the  total  costs  of  carrying 
on  a  business  of  this  nature.  The  enterpriser  rarely  found 
himself  forced  to  adjust  his  business  with  a  view  to  obtain- 
ing the  greatest  possible  use  from  a  definite  amount  of 
land.  If  his  capital  sufficed  for  so  large  a  business,  he 
purchased  or  leased  a  city  block  on  which  to  erect  his  build- 
ings ;  if  his  capital  was  small,  he  limited  his  use  of  land  to 


98  INTRODUCTION   TO   ECONOMICS 

a  few  lots.  To-day  conditions  have  changed,  in  conse- 
quence of  the  extraordinary  growth  of  the  cities.  The 
merchant  who  desires  to  carry  on  a  business  in  the  heart 
of  the  business  district  of  a  great  city  often  finds  himself 
restricted  to  a  given  number  of  front  feet.  The  adjacent 
lots  are  taken  up  by  establishments  which  show  no  dis- 
position to  remove.  It  is  then  a  question  how  to  conduct 
a  maximum  paying  business  upon  a  fixed  ground  space. 

One  way  of  overcoming  the  limitation  of  ground  space 
consists  in  erecting  a  very  lofty  building.  Instead  of  con- 
tenting himself  with  a  building  of  six  stories,  the  enter- 
priser may  push  the  height  to  fifteen  or  more.  Perhaps 
it  costs  $600,000  to  erect  a  six-story  building.  An  ad- 
ditional $100,000  may  possibly  give  another  story;  but 
more  probably  the  seventh  story  will,  in  effect,  cost  more 
than  this.  To  raise  the  building  materials  to  this  height 
is  more  expensive  than  to  raise  materials  to  a  lower  story. 
Moreover,  a  seven-story  building  is  not  merely  a  six-story 
one  with  a  floor  superadded  ;  in  planning  the  taller  build- 
ing, it  is  necessary  to  allow  for  greater  strength  of  wall  in 
the  lower  stories,  in  view  of  the  additional  weight  to  be 
borne  by  them.  Greater  care  must  be  exercised  to  reduce 
risk  from  fire.  In  addition  to  the  increased  cost  of  con- 
struction, there  will  be  greater  costs  in  connection  with  the 
permanent  use  of  the  seventh  floor  than  in  connection  with 
the  use  of  lower  floors.  More  labor  will  be  spent  in  carry- 
ing up  the  goods  to  be  exposed  for  sale,  and  in  carrying 
down  the  articles  sold.  More  numerous  and  more  power- 
ful elevators  will  be  required  for  the  higher  building.  We 
may  therefore  place  the  initial  cost  of  the  additional  floor 
at  $120,000. 

An  eighth  floor  would,  in  effect,  cost  still  more  than  the 
seventh  —  $140,000,  let  us  say.  A  ninth  floor  may  cost 
$160,000;  a  tenth  floor  $180,000,  and  the  fifteenth  floor 
may  cost  $280,000.     As  there  is  no  reason  for  supposing 


THE   LAW   OF    DIMINISHING    RETURNS  99 

that  the  higher  floors  will  accommodate  more  business 
than  the  lower,  it  is  clear  that  the  returns  on  capital 
expended  diminish  with  each  additional  floor. 

7.  The  principle  of  diiniiiisJiiiig  retiinis  is  illustrated  by 
tJie  results  of  iucreasiiig  the  rolling  stock  of  a  transportation 
company  ivithont  increasing  trackage. 

In  a  certain  city  a  street  railway  company,  let  us  assume, 
has  extended  its  hnes  of  track  through  all  the  streets  which 
promise  any  considerable  traffic.  The  trackage  is  then  a 
fixed  element  in  the  company's  business,  analogous  with 
the  land  of  the  farmer  or  the  floor  space  of  the  merchant. 
The  variable  elements  are  labor,  fuel  for  power,  and  aux- 
iliary capital  in  the  shape  of  cars. 

With  one  hundred  cars  in  the  entire  system,  running  at 
intervals  of  twenty  minutes,  the  company  may  carry  an 
average  of  one  hundred  passengers  per  car  per  trip,  thus 
earning  $5.  It  is  easy  to  see  that  the  number  of  pas- 
sengers carried  would  be  increased  if  the  service  were 
more  frequent.  Persons  who  have  only  a  short  distance 
to  go  will  form  the  habit  of  walking,  if  the  alternative 
usually  means  waiting  fifteen  or  twenty  minutes  for  an 
overcrowded  car.  Quite  possibly  the  company  would  get 
twice  as  many  fares  with  two  hundred  cars,  running  at 
intervals  of  ten  minutes..  In  this  case  the  tendency  of 
returns  to  diminish  does  not  appear. 

Imagine  now  that  the  company  places  a  third  hundred 
cars  upon  its  lines,  still  further  reducing  the  intervals  be- 
tween cars.  In  large  measure  these  cars  will  simply  carry 
passengers  who  would  have  been  carried  by  the  other 
cars  ;  and  this  is,  of  course,  no  gain  to  the  company.  The 
greater  efficiency  of  the  system,  and  the  greater  comfort 
of  riding  in  cars  that  are  never  overcrowded,  will  develop 
some  increase  in  traffic.  Possibly  this  increase  will  amount 
to  fifty  passengers  for  each  of  the  new  cars.  Each  of  the 
new  cars  would  thus  represent  an  addition  of  $2.50  to  the 


roo  INTRODUCTION   TO   ECONOMICS 

income  of  the  company.  An  additional  hundred  cars  may 
increase  the  number  of  passengers  carried  by  an  average 
of  twenty-five  for  each  additional  car;  still  another  hundred 
may  increase  the  number  of  passengers  carried  scarcely 
at  all. 

8.  The  principle  of  diniinisJiing  rctuiiis  comes  into  opera- 
tion ivhcn  the  amount  of  labor  increases,  zvhile  the  amount 
of  capital  remains  fixed. 

The  element  in  production  which  operates  to  limit  the 
expansion  of  a  given  business  may  be  capital  in  its  general 
form,  not  any  concrete  productive  good.  It  is  a  fortunate 
business  man  who  finds  his  capital  limited  only  by  the 
possibilities  of  profitable  employment  which  he  commands. 
In  practical  life  a  man  can  secure  for  use  in  his  business, 
besides  his  own  capital,  only  the  additional  capital  for 
which  he  can  give  security.  And  this  is  usually  limited  to 
some  proportion  of  the  value  of  his  own  property. 

Assuming  that  a  manufacturer  possesses  a  capital  of 
$50,000,  and  can  borrow  $50,000  more,  the  sum  $100,000 
limits  his  operations  as  narrowly  as  any  other  fixed  element 
in  his  production  could  do.  He  has,  of  course,  many 
choices  as  to  the  exact  disposition  of  the  capital.  If  he  is 
engaged  in  cotton  manufacture,  he  may  use  first-class 
machinery,  or  he  may  employ  a  poor  grade  of  machines  — 
perhaps  machines  that  have  been  discarded  in  other  sec- 
tions, as  was  for  a  long  time  a  common  practice  in  the 
South.  He  may  decide  upon  investing  $50,000  of  his 
capital  in  looms,  and  the  remainder  partly  in  the  building 
and  partly  in  materials,  etc.  With  twenty-five  laborers  and 
high-grade  looms,  the  output  per  laborer  will  be  high  ;  with 
fifty  laborers  and  lower  grade  looms,  the  output  per  laborer 
will  probably  be  less,  although  the  total  output  of  the  mill 
will  be  increased.  A  third  force  of  twenty-five  laborers 
with  a  still  cheaper  grade  of  looms  will  add  something  to 
the  total  output,  but  the  output  per  man  will  be  still  further 


THE   LAW    OF    DIMINISHING    RETUF^NS  lOl 

diminished.  Pcrhai)s  the  output  i)er  man,  when  twenty  five 
are  employed,  will  be  $2000.  With  cheaper  looms  and 
fifty  men,  the  output  per  man  may  be  $1900.  Seventy-five 
men,  with  the  capital  put  into  appropriate  form,  might 
produce  $1800  per  man.  With  one  hundred  men,  the 
returns  per  man  might  be  $1700,  and  with  each  further 
addition  to  the  number  of  men  a  corresponding  decrease 
in  product  per  man  might  take  place,  until  at  last  additional 
laborers  added  nothing  to  the  output. 

9.  The  principle  of  dinii)iis]ii)ig  returns  is  of  universal 
application  in  the  field  of  production. 

Wherever  one  element  in  production  is  fixed,  while  the 
other  factors  in  production  increase,  the  principle  of 
diminishing  returns  inevitably  operates.  Wherever  one 
factor  in  production  increases,  while  the  other  factors  in- 
crease at  a  more  rapid  rate,  the  law  of  diminishing  returns 
operates,  but  in  modified  form.  If  the  labor  and  movable 
capital  of  society  increase  while  the  natural  resources  at 
the  command  of  society  fail  to  increase,  diminishing  returns 
appear,  as  in  the  individual  establishments  of  our  examples. 

We  may  now  state  the  law  of  diminishing  returns  in  its 
general  form.  When  ajiy  one  of  the  several  factors  ivhose 
cooperation  is  essential  to  production  is  limited  in  quantity, 
either  absolutely,  or  by  conditions  of  increasing  cost,  while 
the  quantity  of  the  other  factors  may  be  increased  practically 
tvithout  limit,  every  unit  of  increase  in  the  variable  factors 
results  in  an  increase  of  output  less  than  proportionate  to  the 
increase  in  the  variable  factors. 

10.  Economy  in  production  is  at  its  maximum  whoi  the 
final  expenditure  on  the  variable  factors  fust  equals  the 
return  to  those  factors. 

The  manufacturer  who  erects  a  mill  to  utilize  the  power 
obtained  by  damming  a  stream,  is  limited  in  his  operations 
by  the  power  represented  by  the  head  of  water.  This  is 
the  fundamental  limiting  element  in  his  calculations.     But 


102  INTRODUCTION   TO   ECONOMICS 

it  is  not  to  be  supposed  that  the  power  which  he  will  actu- 
ally obtain  is  a  definite  quantity.  Human  ingenuity  has 
devised  no  means  whereby  all  the  power  actually  resident 
in  any  natural  source  may  be  transmuted  into  a  form  which 
lends  itself  to  use.  All  our  devices  for  securing  and  trans- 
mitting power  are  imperfect;  the  best  of  them  are  only 
less  wasteful  of  energy  than  the  worst.  Our  manufacturer 
may  install  a  mechanism  which  costs  little  but  permits  a 
large  part  of  the  power  to  go  to  waste,  or  he  may  install 
a  more  complicated  and  costly  set  of  devices,  which  will 
come  far  nearer  turning  to  account  the  whole  power  repre- 
sented by  the  fall.  We  may  think  of  the  manufacturer  as 
weighing  the  advantages  of  different  kinds  of  power  plant. 
The  expenditure  of  ;$iooo  will  permit  the  utilization  of,  per- 
haps, one  half  of  the  power.  A  second  $rooo  may  make 
it  possible  to  utilize  two  thirds  of  the  power.  With  a  plant 
costing  $3000  perhaps  three  fourths  of  the  total  power  will 
be  utilized.  A  $4000  plant  may  utilize  four  fifths  of  the 
power,  and  so  on.  At  what  point  will  it  be  more  profitable 
to  let  power  go  to  waste  than  to  incur  additional  expense 
to  save  it .''  One  half  of  the  power  may  have  a  value  of 
$300  per  year.  Interest  and  depreciation  on  the  $1000 
necessary  to  obtain  this  power  may  amount  to  $150.  The 
value  of  the  power  which  would  be  obtained  through  the 
$2000  plant,  on  the  basis  we  have  assumed,  would  be  $400 ; 
and  the  cost,  figuring  interest  and  depreciation  as  before, 
would  be  $300.  The  simple  plant  therefore  would  yield  a 
net  value  of  $150  above  cost;  while  the  more  complicated 
plant  would  yield  only  $100.  It  would  accordingly  pay 
best  to  install  the  $1000  plant.  If  the  value  of  the  power 
should  double,  however,  while  the  cost  of  the  several  kinds 
of  power  installations  remained  unchanged,  the  $1000  plant 
would  yield  a  value  of  $600  at  a  cost  of  $150,  leaving  a  net 
gain  of  $450 ;  while  the  $2000  plant  would  give  a  power 
worth  $800  at  a  cost  of  $300,  leaving  a  net  gain  of  $500. 


THE    LAW    OF    DIMINISIIINd    RETURNS  lo 


J 


The  $3000  plant  would  yield  a  power  worth  $900,  but  at  a 
cost  of  $450.  The  net  gain  is  evidently  diminished  through 
the  installation  of  the  $3000  plant.  The  $2000  plant  is, 
under  the  circumstances,  the  most  economical  available. 
Were  the  value  of  the  power  again  doubled,  the  $3000 
plant  would  yield  the  highest  surplus  above  cost,  and  so 
would  be  the  most  advantageous  economically. 

Under  present  conditions  it  is  an  excellent  steam  engine 
which  transforms  into  mechanical  power  one  sixth  of  the 
energy  of  the  coal  which  it  consumes.  A  simple  and  inex- 
pensive type  of  engine  does  not  do  nearly  so  well  as  this. 
At  a  given  place  and  time,  will  it  be  more  economical  to 
employ  an  engine  of  the  very  highest  type,  and  which 
naturally  is  very  costly,  or  an  inexpensive  engine  of  a  sim- 
ple type  ?  The  former  may  transform  into  power  fifteen 
per  cent  of  the  energy  latent  in  the  coal ;  the  latter,  only 
five  per  cent.  If  the  additional  power  obtained  through  the 
better  engine  docs  not  equal  the  excess  of  interest  and 
depreciation  charge  on  the  more  costly  engine,  the  simpler 
engine  is  the  more  economical  in  spite  of  its  wastefulness 
from  the  mechanical  point  of  view. 

A  farmer  should  continue  his  application  of  labor  and 
capital  to  land  as  long  as  the  returns  from  additional  units 
of  labor  and  capital  exceed  their  cost.  If  wages  and 
interest  decline,  it  becomes  possible  to  increase  the  ap- 
plication of  labor  and  capital  to  land  without  passing  be- 
yond the  bounds  of  economical  production.  Similarly, 
cultivation  may  profitably  be  made  more  intensive  if  the 
prices  of  agricultural  products  rise.  We  have  here  an  ex- 
planation of  the  fact  that  in  old  countries  land  is  cultivated 
more  intensively  than  in  new  countries.  In  the  latter 
wages  and  interest  are  high  and  prices  are  low. 

11.  7'//e  laiv  of  diiitiiiisJiin^^  returns  may  be  counter- 
acted by  iniprovements  in  production. 

Improvements  in  methods  of  production  are  constantly 


I04  INTRODUCTION   TO    ECONOMICS 

taking  place,  with  the  result  that  a  given  amount  of  labor 
or  of  capital  increases  in  efficiency.  If  the  amount  of  labor 
employed  upon  a  hundred-acre  field  increases,  the  increase 
in  product  will  not  ordinarily  be  proportionate  to  the  in- 
crease in  labor.  But  if  at  the  same  time  a  new  way  of 
cultivating  or  fertilizing  the  soil  is  discovered,  or  if  the 
quality  of  the  seed  is  improved,  the  product  may  very  well 
increase  relatively  to  the  amount  of  labor.  This  fact  does 
not  prove  that  the  law  of  diminishing  returns  is  non-exist- 
ent. It  merely  proves  that  there  are  other  forces  at  work 
which  may,  at  times,  neutralize  its  effects.  These  forces 
are,  of  course,  of  the  greatest  practical  importance,  and 
will  later  demand  our  attention. 

Another  qualification  of  the  principle  of  diminishing 
returns  consists  in  the  fact  that  the  very  process  of  in- 
creasing the  number  of  units  of  variable  factors  employed 
in  connection  with  an  unvarying  factor  may,  under  certain 
conditions,  increase  the  productive  efficiency  of  each 
unit  of  the  varying  factors.  To  employ  two  men  on  an 
acre  of  land  that  could  be  cultivated  by  one  would  result  in 
a  diminished  return  per  man  if  each  worked  alone.  But 
many  tasks  may  be  better  performed  when  two  or  more 
men  cooperate  than  when  each  works  by  himself.  Accord- 
ingly, it  may  happen  that  an  increase  in  labor  which  makes 
cooperation  possible,  or  an  increase  in  capital  which  makes 
possible  better  methods,  may  be  accompanied  by  increasing, 
instead  of  diminishing,  returns. 

12.    Summary. 

In  most  businesses  the  enterpriser  is  subject  to  definite 
limitations  in  his  control  over  one  or  more  of  the  factors 
upon  which  his  production  is  based,  while  he  may  be  able 
to  increase  other  factors  without  assignable  limits.  Such 
limitations  upon  some  of  the  factors  in  a  productive  com- 
bination do  not  necessarily  place  an  absolute  limit  upon 
the  size  of  a  business ;  they  do,  however,  imply  that  after 
a  certain  size  has  been  reached,  further  expansion  involves 


THE   LAW    OF    DIMIXISHIXG    RETURNS  105 

disproportionate  expense.  This  principle,  known  as  the 
law  of  diminishing  returns,  is  of  universal  applicabihty  in 
the  field  of  production. 

The  greatest  economy  in  production  is  attained  when 
the  returns  to  the  last  units  of  the  variable  factors  in  a 
business  just  equal  the  cost  of  those  factors.  Ev^ery  reduc- 
tion in  the  cost  of  one  of  the  variable  factors  extends  the 
scope  of  profitable  application  of  that  factor.  The  law 
of  diminishing  returns  may  often  be  counteracted  by  im- 
provements in  production ;  in  some  cases  this  counteract- 
ing influence  may  be  brought  about  by  the  very  forces  that 
tend  to  bring  the  law  of  diminishing  returns  into  operation. 


CHAPTER   VII 

THE   SPECIALIZATION   OF   ECONOMIC   FUNCTIONS 

1.  /;/  primitive  conditions  all  the  functions  of  wealth  pro- 
duction are  peiformed  by  the  single  kins  Jiip  group,  or  family. 

At  the  dawn  of  civilization  men  lived  in  small  groups 
that  were  practically  self-sufficing.  Whatever  work  was  to 
be  done  was  executed  by  all  the  men  in  cooperation,  or  by 
any  member  of  the  tribe  indifferently.  Some  distinction 
there  was  between  the  work  of  men  and  that  of  women ; 
the  former  were  in  many  cases  engaged  chiefly  in  hunting, 
the  latter  in  root  grubbing  and  in  a  primitive  form  of  gar- 
dening. Economic  differentiation,  then,  hardly  existed. 
It  is  true  that  there  was  little  occasion  for  the  specializa- 
tion of  economic  functions,  since  wants  were  few  and 
economic  functions  were  consequently  simple. 

In  many  cases  civilized  men  have  been  placed  in  condi- 
tions that  bear  a  superficial  resemblance  to  those  of  primi- 
tive life.  But  the  civilized  man  carries  with  him  a  great 
number  of  wants  that  the  savage  never  experienced.  We 
therefore  find,  in  such  conditions,  a  progress  in  the  differen- 
tiation of  economic  functions  taking  place  in  a  few  decades, 
while  in  the  history  of  the  human  race  as  a  whole,  differen- 
tiation was  the  result  of  thousands  of  years  of  development. 

In  a  frontier  community,  where  almost  the  entire  popu- 
lation consists  of  independent  families  living  upon  farms, 
the  economic  functions  performed  by  each  person  are 
numerous  and  diverse.  The  frontiersman  must,  in  the  first 
place,  be  an  agriculturist  and  a  grazier.  Each  of  these 
occupations  includes  numerous  functions  calling  for  differ- 
ent qualities,  the  agriculturist  being  a  plowman,  sower, 
reaper,  etc.     The  frontiersman  must  also  be  a  woodcutter 

1 06 


SPECIALIZATION   OF    KCONOMIC    FUNCTIONS    107 

at  times,  a  carpenter,  a  mason,  a  cabinet-maker,  a  smith,  a 
butcher,  and  a  hunter,  not  to  speak  of  a  host  of  miscellaneous 
functions  that  he  must  occasionally  perform.  His  wife 
probably  has  a  no  less  varied  array  of  occupations.  She 
is  a  cook,  a  laundress,  a  seamstress,  a  dairymaid,  a  spin- 
ner, a  weaver,  a  nurse,  and  a  teacher.  To  survive  on  the 
frontier  one  must  be  a  jack  of  all  trades.  And  practically 
the  same  range  of  duties  falls  upon  the  strong  and  the  weak, 
the  intelligent  and  the  dull,  the  man  who  quickly  acquires 
skill  and  the  man  who  acquires  it  with  great  difficulty. 

2.  The  first  stage  in  the  differentiation  of  economic  func- 
tions is  the  exchange  of  services. 

Were  the  frontier  community  wholly  isolated  for  many 
generations,  a  transformation  of  its  methods  of  production 
would  gradually  take  place.  A  person  with  more  than  the 
ordinary  talent  for  building  would  be  called  upon  to  assist 
in  the  construction  of  his  neighbors'  houses,  receiving  in 
return  assistance  in  work  for  which  he  had  no  special  quali- 
fication. Little  by  little,  occupations  would  be  differenti- 
ated, and  eventually  the  community  would  contain  among 
its  population  carpenters,  smiths,  masons,  weavers,  etc. 
While  these  craftsmen  might  still  own  land,  and  spend  their 
odd  hours  in  agriculture,  the  main  source  of  their  livelihood 
would  be  the  exercise  of  their  several  crafts.  Specialization 
in  the  form  known  as  differentiation  of  occupations  would 
thus  have  come  into  existence. 

So  long  as  differentiation  of  functions  rests  upon  a  direct 
exchange  of  services,  it  cannot  be  carried  far.  Population 
would  need  to  be  fairly  dense  before  a  man  could  devote 
himself  exclusively  to  the  building  of  houses,  even  if  he 
undertook  the  work  of  stone  mason,  brick  mason,  and 
plasterer  in  addition  to  that  of  carpenter.  Such  trades  as 
that  of  locksmith  could  harcll\-  exist  at  all,  since  a  scattered 
rural  population  could  scarcely  furnish  work  enough  to 
maintain  it. 


jo8  INTRODUCTION   TO    ECONOMICS 

3.  An  important  step  in  the  direction  of  economic  speciali- 
zation zvas  taken  when  men  began  to  produce  commodities 
for  sale. 

In  early  modern  times  the  development  of  trade  gradu- 
ally transformed  production  for  the  household  into  produc- 
tion for  the  market.  This  change  first  made  its  appearance 
in  the  woolen  industry.  At  first,  we  may  suppose,  only 
the  surplus  of  domestic  production  was  placed  upon  the 
market  of  the  town,  or  carried  to  fairs  where  a  larger  con- 
course of  purchasers  was  to  be  found.  In  time  production 
for  domestic  use  became  a  mere  incident ;  the  weaver  came 
to  depend  on  more  or  less  distant  markets  for  the  sale  of 
his  wares.  And  this  implied  the  purchase  in  the  market 
of  the  materials  of  production.  So  we  find  German  weavers 
in  the  fifteenth  century  carrying  their  wool  from  England 
and  their  finished  products  to  southern  and  eastern  Europe. 
Under  these  conditions  there  was  no  reason  why  a  man 
should  produce  more  than  one  kind  of  cloth.  A  great  body 
of  consumers  was  within  his  reach,  and  however  special  his 
product,  he  could  devote  himself  exclusively  to  it. 

In  like  manner,  traders  would  soon  appear  in  the  frontier 
community  of  our  example,  and  carry  away  the  lighter  sur- 
plus products,  giving  in  exchange  the  manufactured  goods 
of  older  communities.  A  railroad  would,  in  time,  transform 
the  frontier  community  into  an  integral  part  of  the  civilized 
world.  Instead  of  weaving  its  own  cloth,  it  would  barter 
its  surplus  products  of  the  soil  for  textiles  produced  in  other 
parts  of  the  world.  The  community  as  a  whole  would  thus 
be  specialized  to  the  functions  best  adapted  to  its  conditions. 

As  the  community  advanced  in  numbers  and  wealth  one 
function  after  another  would  be  taken  out  of  the  province 
of  the  man  of  all  work,  and  given  over  to  persons  specially 
qualified  by  nature  and  training  to  perform  it  effectively. 
Each  trade,  again,  would  tend  to  subdivide.  The  carpen- 
ter would    no   longer   plan    the    building  upon  which   he 


SPFXIALIZATION    OF    ECONOMIC    FUNCTIONS    109 

worked,  this  function  being  given  over  to  the  architect. 
The  planing  of  boards  v^ould  cease  to  be  a  part  of  the  car- 
penter's v^ork,  as  planing  mills  would  be  established  which 
would  do  the  work  far  more  economically.  Even  in  agri- 
culture some  differentiation  would  take  place ;  one  man 
would  devote  himself  chiefly  to  the  growing  of  grain,  an- 
other to  raising  vegetables,  etc.  Owing  to  the  seasonal 
character  of  agricultural  labor,  however,  and  the  advan- 
tages of  combining  crops  in  such  a  way  that  the  work  may 
be  distributed  as  evenly  as  possible  throughout  the  open 
months,  specialization  in  agriculture  could  not  be  carried 
very  far.  Indeed,  even  in  the  best  developed  agriculture, 
we  do  not  find  some  farmers  wholly  devoted  to  wheat  cul- 
ture, others  growing  nothing  but  corn,  others  potatoes  or 
turnips.  Agriculture  by  its  nature  precludes  a  high  degree 
of  differentiation  of  functions. 

4.  Differentiation  of  function  in  production  is  in  large 
measure  dependent  upon  the  character  of  the  existing  com- 
mercial organization. 

In  the  mediaeval  towns  the  artisan  was  at  the  same  time 
a  trader.  He  was  compelled  to  supply  himself  with  mate- 
rials, often  from  distant  sources;  he  was  often  compelled 
to  carry  his  wares  from  place  to  place  in  order  to  find 
purchasers.  The  risks  incident  to  procuring  materials  and 
marketing  products  weighed  heavily  upon  him.  Cooper- 
ation, as  in  the  German  Hanse  towns,  reduced  his  difficul- 
ties in  some  measure;  nevertheless,  under  the  conditions, 
comparatively  few  men  could  rely  for  their  subsistence 
upon  a  single  occupation.  With  the  development  of  a 
merchant  class,  the  producer  was  relieved  of  the  labor  and 
risks  of  assembling  materials  and  marketing  products.  The 
accumulation  of  large  and  permanent  stocks  of  material 
gave  occasion  for  a  constantly  increasing  number  of  occu- 
pations, or  subdivisions  of  occupations. 

As  an  illustration  of  the  effect  of  commercial  develop- 


no  INTRODUCTION   TO   ECONOMICS 

meat  upon  the  division  of  labor,  we  may  cite  the  industry 
of  shoe  manufacture.  One  hundred  years  ago  shoe  mak- 
ing was  carried  on  by  independent  cobblers,  supplying  a 
local  demand.  Every  cobbler  made  many  types  of  boots 
and  shoes.  At  a  somewhat  later  period,  shoes  had  become 
an  article  of  commerce,  and  the  cobbler  ceased  to  be  de- 
pendent on  the  local  demand.  In  the  next  stage  in  the 
process  of  development,  the  commercial  demand  for  shoes 
had  become  too  important  to  allow  the  supply  to  remain 
dependent  upon  the  enterprise  of  the  independent  cobbler. 
The  merchant  began  to  furnish  material  ready  cut  to  be 
sewed  and  pegged  by  persons  capable  of  doing  the  work, 
whether  trained  in  the  trade  or  not.  In  this  stage  the 
simpler  processes  were  performed  by  one  set  of  hands,  the 
more  complicated  by  another.  Thus  division  of  labor  had 
succeeded  differentiation  of  occupations.  Further  improve- 
ments in  methods  of  marketing  the  finished  product  led  to 
still  more  minute  division  of  labor,  under  the  factory  form 
of  organization.  To-day  each  shoe  goes  through  scores  of 
hands  before  it  is  placed  on  the  market  as  a  finished 
product. 

A  similar  evolution  may  be  traced  in  the  ready-made 
clothing  industry  —  a  still  newer  field.  The  retail  and 
wholesale  clothing  trade  has  grown  up  in  the  last  fifty 
years ;  its  increasing  demands  have  given  a  stimulus  to 
the  differentiation  of  functions  in  the  making  of  clothes. 
It  is,  of  course,  to  be  borne  in  mind  that  in  all  cases  the 
development  of  trade  and  the  differentiation  of  economic 
functions  have  proceeded  concurrently.  Each  has  been 
in  part  the  effect,  in  part  the  cause,  of  the  other. 

5.  luiproveincjits  in  tj'ansportatio7i  give  occasion  to  in- 
creased specialization  in  industry. 

Division  of  labor  first  reached  a  high  degree  of  develop- 
ment in  centers  enjoying  water  transportation.  Until 
recent  times,  it  was  only  at  such  centers  that    the  more 


SPECIALIZATION   OF   ECONOMIC   FUNCTIONS    ill 

bulky  materials  of  industry  could  be  assembled  in  suffi- 
ciently large  quantities  to  permit  extensive  subdivision  of 
functions  ;  furthermore,  it  was  only  from  such  centers  that 
it  was  possible  to  carry  bulky  goods  to  a  great  number  of 
consumers.  The  advent  of  the  railway  enabled  inland 
cities  to  engage  in  highly  specialized  production.  As  rail- 
way service  became  better  and  cheaper,  many  forms  of 
industry  permitting  a  minute  division  of  labor  appeared. 
Until  refrigeration  had  been  reduced  to  a  science,  and  the 
methods  of  transporting  products  preserved  by  ice  had  been 
perfected,  every  locality  depended  for  its  supply  of  meat 
upon  the  local  butcher.  If  the  consumers  in  the  vicinity 
were  few,  they  were  ordinarily  supplied  by  small  shops 
which  permitted  only  a  low  degree  of  division  of  labor.  In 
the  cities,  the  shops  were  larger,  and  division  of  labor  was 
carried  farther.  To-day  there  is  almost  no  limit  to  the 
market  for  a  single  establishment.  Fresh  meats  from 
Chicago  may  be  found  in  practically  any  city  or  town  in 
the  land.  Fresh  mutton  killed  in  New  Zealand  and 
Australia  finds  a  ready  market  in  England.  The  parallel 
development  of  live  stock  transportation  has  given  the 
slaughtering  centers  a  practically  unlimited  supply  of  raw 
material.  Accordingly,  a  minute  division  of  labor  has  been 
evolved  in  the  slaughterhouses.  In  the  Chicago  slaughter- 
houses the  killing  and  dressing  of  a  bullock  is  subdivided 
into  fifty  or  sixty  separate  functions,  each  assigned  to  a 
separate  set  of  workmen.  Each  set  makes  some  small 
change  in  the  material  and  passes  it  on  to  another  set. 
Of  course  some  functions  are  performed  by  single  work- 
men, some  by  several.  The  laborers  are  organized  in 
gangs  of  230  men,  each  gang  containing  just  the  appro- 
priate number  of  men  of  each  class. 

6.  ///  tJie  field  of  production  at  the  order  of  the  coiisjimcr, 
division  of  labor  is  depe?ident  largely  upon  the  density  of 
population. 


112  INTRODUCTION   TO    ECONOMICS 

Where  the  producer  of  a  commodity  deals  directly  with 
the  consumer,  the  opportunity  for  minute  division  of  labor 
is  not  so  great  as  where  the  producer  is  brought  into  rela- 
tion with  the  consumer  through  the  intermediation  of  a 
general  market.  The  amount  of  work  that  may  be  secured 
by  a  single  custom-tailor's  shop  is  limited  by  the  number  of 
purchasers  of  custom-made  garments  within  easy  distance. 
In  a  village  this  number  may  be  so  small  that  anything 
like  subdivision  of  the  tailor's  trade  is  impracticable.  In 
a  large  city  the  case  is  different.  A  single  shop  may  easily 
find  customers  enough  to  keep  twenty  men  at  work.  In 
the  latter  case  division  of  labor  is  entirely  practicable.  If 
transit  facilities  in  the  large  city  are  excellent,  the  number 
of  men  that  may  be  employed  by  a  single  tailoring  estab- 
lishment may  be  one  hundred  or  more,  and  labor  may  be 
as  minutely  subdivided  as  the  employer  desires.  In  the 
making  of  furniture  at  the  order  of  the  consumer,  similar 
limitations  upon  division  of  labor  are  found.  The  small 
town  is  able  to  support  only  a  small  shop,  where  all  the 
work  is  performed  by  two  or  three  men,  while  the  large 
city  renders  possible  the  large  shop,  with  minute  subdivi- 
sion of  labor. 

7.  The  degree  in  zvJiicJi  tlie  functions  of  production  may 
be  siibdivided  is  dependent  upon  the  prevailing  form  of  eco- 
fiomic  organization. 

Where  each  workman  is  his  own  employer,  as  was  gen- 
erally the  case  in  the  mediaeval  industrial  organization, 
labor  cannot  be  very  minutely  subdivided.  In  such  an 
industrial  organization  the  spinner  buys  his  wool  and  sells 
his  product  to  the  weaver;  the  latter  sells  the  cloth  to  the 
fuller,  who,  in  turn,  sells  it  to  the  dyer.  The  product  is 
again  sold,  perhaps,  to  the  shearer,  who  in  turn  sells  the 
finished  cloth  to  the  draper,  who  deals  directly  with  the 
consumer.  With  such  a  form  of  organization  much  time 
is  necessarily  wasted  in  the  buying  and  selling  of  the  mate- 


SPECIALIZATION   OF   ECONOMIC   FUNCTIONS    113 

rial  in  its  several  stages,  and  the  greater  the  number  of 
stages,  the  greater  the  waste  from  this  source.  Again,  as 
each  person  follows  his  own  taste  in  choosing  his  trade  — 
subject,  of  course,  to  family  tradition  and  trade  restrictions 
—  it  is  unlikely  that  the  society  will  have  just  the  right 
number  of  craftsmen  of  each  kind.  At  one  time  there  will 
be  too  many  spinners,  relatively  to  the  number  of  weavers; 
at  another  time  fullers  will  be  so  numerous  that  not  all  can 
be  employed.  And  this  element  of  waste  also  increases 
with  increasing  subdivision  of  labor. 

Where,  on  the  other  hand,  industry  is  carried  on  under 
the  factory  system,  the  workmen  are  assembled  under  one 
roof,  subject  to  the  control  of  an  employer.  The  material 
passes  through  the  shop  without  interruption,  and  appren- 
tices are  taken  on  in  each  branch  in  the  proportions  which 
experience  shows  to  be  most  desirable.  Of  course  this 
implies  a  large  accumulation  of  wealth  on  the  part  of  the 
employer,  who  must  provide  the  premises,  furnish  materials, 
pay  wages,  and  assume  all  other  expenses  of  production. 
In  fact,  we  may  say  that  large  capital  and  efficient  manage- 
ment are  prerequisites  to  a  thoroughgoing  system  of  divi- 
sion of  labor.  And,  of  course,  efficient  management  on 
the  part  of  the  employer  implies  a  corresponding  readiness 
to  submit  to  direction  on  the  part  of  the  employee.  We 
might  easily  conceive  of  a  society  in  which  all  other  condi- 
tions requisite  to  division  of  labor  might  exist,  but  in  which 
division  of  labor  of  an  advanced  type  would,  nevertheless, 
be  impracticable  on  account  of  the  restlessness  of  the 
working  population  under  close  direction. 

8.  From  a  business  point  of  vieiv,  the  principal  advan- 
tages of  division  of  labor  are  (i)  increased  skill  and  speed 
in  production  ;  (2)  less  ivastc  of  time  ;  (3)  greater  ease  of 
supervision. 

To  enumerate  all  the  advantages  of  the  division  of  labor 
would  require  a  volume ;    but  we  may  group  the  more 


114  INTRODUCTION   TO   ECONOMICS 

important  ones  under  a  few  heads.  In  the  first  place,  the 
limitation  of  the  labor  to  be  performed  by  one  man  to  a 
single  function,  which  involves  the  use  of  a  single  tool, 
and  which  may  be  reduced  to  a  few  simple  movements, 
makes  possible  accurate  workmanship  and  great  speed, 
with  relatively  little  weariness.  The  workman  soon  re- 
duces his  movements  to  a  rhythm  ;  he  grasps  each  piece 
of  material  in  the  same  way,  delivering  his  strokes  upon  it 
in  such  a  way  as  never  to  throw  away  his  energy.  Every 
one  knows  how  much  better  results  a  trained  oarsman 
secures  from  the  expenditure  of  a  given  amount  of  muscu- 
lar energy  than  the  raw  beginner,  who  puts  forth  his 
strength  now  on  the  water,  now  on  the  air,  now  in  the 
right  direction,  now  in  the  wrong  one.  The  difference  in 
effectiveness  between  the  strokes  delivered  by  the  man  who 
works  with  a  single  tool,  and  the  strokes  delivered  by  one 
who  works  with  a  dozen  tools,  is  hardly  exaggerated  by 
the  comparison. 

The  best  workman  loses  some  time  in  changing  from  tool 
to  tool.  It  is  not  difficult  to  find  a  carpenter  who  spends 
many  fruitless  moments  searching  now  for  his  saw,  now  for 
his  hammer,  while  the  whereabouts  of  the  plane  or  square, 
when  these  implements  are  needed,  proves  a  baffling,  if  not 
insolvable,  problem.  And  this  "is  the  man  who  leaves  his 
work  with  the  loudest  complaints  of  his  weariness.  A  divi- 
sion of  labor  that  holds  a  man  so  strictly  to  business  that 
he  never  has  a  chance  to  stop  to  search  for  anything,  con- 
tributes materially  to  reduce  such  waste  of  time  and  energy. 

The  simpUfication  of  the  task  of  each  laborer  makes  it  a 
comparatively  easy  matter  to  ascertain  how  much  any  par- 
ticular one  is  actually  doing.  One  who  has  lived  in  the 
country  has  probably  made  the  acquaintance  of  two  types 
of  laborers :  the  first,  those  who  are  always  bustling 
about  in  a  hurry  and  yet  accomplishing  little;  the  second, 
never  in  a  hurry,  yet  showing,  in  the  end,  a  good  record  of 


SPECIALIZATION   OF    ECONOMIC   FUNCTIONS    115 

achievement.  Because  of  the  miscellaneous  character  ot 
the  work  of  the  agricultural  laborer,  it  takes  a  long  time  to 
measure  the  relative  efificiency  of  different  men.  Where  a 
man  is  compelled  to  repeat  the  same  operation  throughout 
the  day,  no  show  of  bustling  energy  will  create  the  illusion 
of  achievement.  The  pieces  of  work  done  have  simply  to 
be  counted  to  give  an  accurate  idea  of  the  laborer's  effi- 
ciency. It  is  obvious,  then,  that  the  difficulty  of  supervi- 
sion is  greatly  reduced  by  systematic  division  of  labor. 

9.  From  a  social  point  of  view,  the  pri}icipal  advantages 
of  division  of  labor  arc  .*  ( i )  tJiat  it  affords  a  place  of  useful- 
ness to  many  who  zvould  otheriuise  be  of  little  use  to  society ; 
(2)  that  it  pe7nnits  each  to  put  his  abilities  to  the  best  account; 
and  (t,)  that  it  facilitates  mechanical  progress. 

Under  frontier  conditions,  where  each  man  must  perform 
a  wide  variety  of  functions,  some  prove  utter  failures,  wast- 
ing so  much  time  turning  irresolutely  from  task  to  task 
that  they  accomplish  nothing.  These  same  men  might 
prove  highly  efificient  workmen  under  different  industrial 
conditions.  If  our  frontier  communities  had  kept  detailed 
records,  we  should  find  that  they  contained  many  a  man 
who  would  have  made  a  good  architect  or  engineer,  many 
a  woman  who  would  have  made  an  excellent  modiste  or 
teacher,  but  who  proved  hopeless  failures  in  the  environ- 
ment in  which  they  were  placed.  Architecture  and  engi- 
neering, designing  of  costumes  and  teaching  of  children, 
were  indeed  functions  not  wholly  neglected,  but  they  made 
up  a  very  small  part  in  the  life  of  each  famil^and  gave 
little  opportunity  to  any  one  for  the  full  development  of 
his  natural  talents. 

Division  of  labor  makes  it  possible  for  persons  who  have 
not  the  time  or  the  versatility  to  learn  how  to  perform  a 
variety  of  functions  to  attain  to  a  place  of  usefulness  in 
industry.  There  are  many  persons  who  cannot  afford  the 
time  to  learn  the  tailor's  trade ;  many  who  have  the  time 


Ii6  INTRODUCTION   TO    ECONOMICS 

for  apprenticeship,  but  not  the  general  abihty  required  foi 
the  making  of  a  well-fitting  coat.  Few  persons  are  so 
stupid  that  they  cannot,  with  slight  waste  of  time,  learn 
how  to  sew  a  straight  seam.  If  the  work  of  making  a  coat 
is  distributed  among  a  dozen  persons,  each  one  can  quickly 
learn  to  do  well  his  particular  part.  Further,  in  the  dis- 
tribution of  the  work,  each  one  may  be  given  a  task  pro- 
portioned to  his  ability.  The  skilled  cutler  will  not  waste 
his  time  picking  basting  threads,  and  the  person  for  whom 
the  latter  function  is  a  sufficient  profession,  will  be  kept 
from  spoiling  material  through  attempting  something  more 
ambitious. 

Perhaps  the  greatest  advantage  that  arises  from  division 
of  labor  is  the  stimulus  it  gives  to  the  invention  of  labor- 
saving  machinery.  A  hundred  years  ago  it  would  have 
seemed  quite  impossible  to  manufacture  shoes  largely  by 
machinery.  The  process  of  manufacture  appeared  so  com- 
plicated that  hand  labor  alone  would  answer.  To-day  shoes 
are  largely  the  product  of  machines.  Many  forces  cooper- 
ated, of  course,  to  bring  about  this  resillt,  but  only  one  of 
these  concerns  us  here,  the  division  of  labor.  When  a  com- 
plicated operation  like  the  making  of  a  shoe  is  split  up  into 
several  score  of  simpler  operations,  some  of  these  are  likely 
to  prove  so  nearly  mechanical  that  the  idea  of  machines  to 
take  over  the  work  suggests  itself.  If  the  process  of  pro- 
duction is  divided  into  twenty-five  parts,  perhaps  the  third, 
and  eleventh,  and  seventeenth  are  taken  over  by  machines. 
In  time  division  of  labor  still  further  simplifies  the  remain- 
ing operations ;  additional  ones  prove  to  be  fitted  for 
machine  work,  and  thus  more  of  the  hand-workers  are 
displaced.  It  is  conceivable  that  in  the  end  practically  the 
whole  process  might  be  taken  over  by  machines,  while  the 
hand-worker  might  be  transformed  into  an  attendant  of  the 
machine,  so  to  speak,  feeding  it  with  material,  and  passing 
on  the  product  to  another  machine. 


SPFXIALIZATION    OF    ECONOMIC    FUXXTIOXS     117 

10.  From  a  social  point  of  view  the  division  of  labor  is 
attended  by  serious  draivbacks. 

The  division  of  labor  greatly  increases  the  productive 
efficiency  of  the  social  working  force,  and  this  is  from 
every  point  of  view  an  advantage.  It  makes  possible  the 
utilization  of  many  forms  of  labor  that  would  otherwise 
find  no  place  in  the  productive  organization.  This  is  an 
advantage  when  the  form  of  labor  utilized  is  incapable  of 
development,  as  in  the  case  of  adults  below  the  average 
in  strength  or  in  intelligence.  Persons  who  would  have 
to  starve  or  beg  under  a  system  of  complicated  employ- 
ments are  often  able  to  earn  a  fair  living  under  a  system 
of  simplified  employments. 

On  the  other  hand,  the  division  of  labor,  and  the  accom- 
panying development  of  machinery,  give  inducement  to 
the  employment  of  classes  that  should  not  be  employed 
at  steady  and  monotonous  labor.  Small  children  and  per- 
sons failing  in  health  are  drawn  into  the  circle  of  sustained 
labor.  The  former  should  be  allowed  to  develop  their 
faculties  in  a  natural  way ;  the  latter,  to  recover  their 
health.  When  each  employment  required  all  the  faculties 
of  a  normal  man,  there  was  nothing  to  tempt  producers  to 
employ  laborers  of  this  class.  Since  the  introduction  of 
division  of  labor,  the  evil  of  employing  those  who  should 
not  be  employed  has  assumed  serious  proportions.  Legis- 
lation has  been  invoked  to  limit  the  employment  of  chil- 
dren, but  in  few  countries  has  child  labor  been  subjected 
to  wholly  satisfactory  regulation. 

Another  serious  disadvantage  of  the  division  of  labor  is 
that  it  tends  to  reduce  the  pleasure  men  derive  from  their 
work.  The  artisan  who  produces  a  completed  piece  of 
work  usually  takes  an  active  interest  in  it.  The  carpenter 
takes  pride  in  the  houses  he  has  built ;  the  cabinet  maker, 
in  the  furniture  that  has  come  from  his  shop.  It  is  a 
common  thing  to  find   men   belonging  to  these  trades  — 


Il8  INTRODUCTION    TO    ECONOMICS 

representatives  of  the  earlier  order  —  reluctantly  leaving 
their  work  when  the  whistle  blows  or  the  foreman  shouts 
"Time  up."  Not  so  with  the  workman  whose  day  is 
spent  in  performing  some  minute  part  of  the  work  of 
producing  each  one  of  a  multitude  of  like  commodities. 
His  part  in  production  is  merged  with  that  of  his  numerous 
fellows.  He  may,  while  young  and  enthusiastic,  take  pride 
in  the  achievements  of  the  establishment  where  he  is  em- 
ployed ;  but  for  the  most  part,  his  interest  in  the  work  is 
dependent  on  his  prospect  of  receiving  increased  pay. 

A  further  disadvantage  of  division  of  labor  is  that  it 
renders  the  workman  dependent  on  a  certain  kind  of  work, 
and  therefore  exposes  him  to  the  risk  of  non-employment 
when  supplies  of  material  are  wanting  or  when  markets 
fail.  There  are  in  most  modern  countries  many  men  and 
women  who  are  well-trained  textile  workers,  but  who  do 
not  know  how  to  find  other  employment  when  a  crisis 
causes  a  contraction  of  the  textile  industry.  The  higher 
the  degree  of  specialization,  the  more  serious  are  the 
effects  of  changes  in  industrial  conditions. 

11.  Progress  in  the  specialization  of  economic  functions 
is  subject  to  a  law  of  diminishing  returns. 

We  may  now  consider  how  far  the  principle  of  division 
of  labor  modifies  the  operation  of  the  principle  of  diminish- 
ing returns,  described  in  the  last  chapter.  According  to 
the  latter  principle,  an  increase  in  the  amount  of  labor 
employed  in  connection  with  a  limited  amount  of  capital 
gives  a  return  which  is  not  proportionate  with  the  increase 
in  labor.  But  what  if  the  additional  laborers  give  oppor- 
tunity for  division  of  labor  which  had  not  before  existed } 
Suppose  that  a  tailor's  shop  with  a  capital  of  $20,000 
formerly  employed  six  men;  it  now  employs  twelve  men. 
Division  of  labor  can  be  carried  farther  with  twelve  men  ; 
hence  is  it  not  possible  that  the  employment  of  the  second 
six  men  will  double  the  output  of  the  shop }     This  is  quite 


SPECIALIZATION    OF    ECONOMIC    FUNCTIONS     ii^ 

possible.  An  additional  six  men  will  give  occasion  to  still 
more  systematic  division  of  labor,  and  so  may  still  further 
increase  the  efficiency  of  each  man.  And  so  with  a  fourth 
set  of  six  men.  But  it  is  evident  that  one  cannot  go  on 
indefinitely  subdividing  the  work  of  making  a  coat.  Even- 
tually a  point  will  be  reached  where  further  subdivision  of 
labor  increases  the  efficiency  of  each  laborer  only  slightly  ; 
still  further  subdivision,  even  less ;  finally  a  degree  of  sub- 
division will  be  found  that  will  not  pay.  That  is,  the  prin- 
ciple of  division  of  labor  is  itself  subject  to  diminishing 
returns.  A  practical  illustration  of  this  fact  is  to  be  found 
in  the  organization  of  the  working  force  in  many  large 
establishments  where  much  use  is  made  of  division  .of  la- 
bor. The  making  of  a  complete  article  is  not  assigned  to 
a  single  man ;  nor  is  it  assigned  to  all  the  men  in  the  shop. 
Each  article  is  assigned  to  a  "team,"  among  the  members 
of  which  the  successive  manipulations  of  the  material  are 
distributed.  The  entire  working  force  may  contain  scores 
of  teams.  Now,  the  size  of  each  team  indicates  the  limits 
of  the  profitable  division  of  labor.  If  an  enterpriser  limits 
each  team  to  sixty  men,  this  is  proof  that  in  his  opinion 
a  team  of  seventy  men  would  not  show  so  large  a  product 
per  man. 

We  may  grant  that  an  increase  in  laborers  employed  in 
connection  with  a  given  capital  may  possibly  result  in  an 
increase  in  product  more  than  proportionate  to  the  in- 
crease in  labor.  This  may  hold  true  until  the  number  of 
laborers  is  sufficient  to  compose  a  team  of  maximum  effi- 
ciency. If  an  additional  team  is  engaged,  without  increase 
in  capital,  it  is  doubtful  if  returns  will  increase  in  pro- 
portion to  the  number  of  teams ;  a  third  team  will  show  a 
return  less  than  that  of  the  second,  and  so  on  until  the 
point  is  reached  where  it  does  not  pay  to  employ  an  addi- 
tional team.  So  far  as  the  principle  of  division  of  labor  is 
concerned,  then,  the  only  qualification  to  be  made  in  the 


I20  INTRODUCTION   TO    ECONOMICS 

law  of  diminishing  returns  is  that  when  we  assume  that 
labor  increases,  we  must  assume  that  it  increases  by  teams, 
not  by  individual  men. 

12.    Summary. 

In  the  course  of  economic  evolution,  one  after  another  of 
the  functions  of  the  primitive  family  group  has  been  taken 
over  by  persons  who  make  a  specialty  of  it.  The  develop- 
ment of  exchange  has  been  a  condition  and  a  cause  of  the 
tendency  toward  specialization.  The  differentiation  of 
economic  functions  may  rest  with  the  assignment  to  each 
individual  of  a  particular  trade,  or  it  may  be  carried  so  far 
as  to  subdivide  the  work  of  a  single  trade.  In  the  former 
case  .we  have  what  is  known  as  differentiation  of  occupa- 
tions ;  in  the  latter,  division  of  labor. 

A  high  degree  of  division  of  labor  presupposes  a  well 
developed  commercial  organization.  Improvements  in 
transportation  increase  the  number  of  fields  in  which  the 
principle  may  operate,  as  does  also  increase  in  the  density 
of  population.  In  a  society  in  which  production  is  carried 
on  by  employer-capitalists  with  hired  factory  workers  divi- 
sion of  labor  can  be  carried  much  farther  than  in  a  society 
in  which  the  laborer  works  on  his  own  account. 

The  productive  power  of  society  has  been  greatly  in- 
creased by  differentiation  of  functions.  The  subdivision  of 
tasks  makes  it  possible  for  each  individual  to  find  work 
commensurate  with  his  capacity,  and  facilitates  mechanical 
progress.  On  the  other  hand,  it  encourages  employers  to 
substitute  child  labor  for  the  labor  of  men,  and  it  destroys, 
in  large  measure,  the  pleasure  that  men  find  in  their  work. 

Up  to  a  certain  point  progress  in  the  division  of  labor 
neutralizes  the  effect  of  diminishing  returns.  But  division 
of  labor  is  itself  subject  to  diminishing  returns;  the  earlier 
stages  in  the  process  are  more  fruitful  than  the  later  ones. 


CHAPTER   VIII 


THE  CONCENTRATION  OF  INDUSTRY 

1.  The  average  size  of  the  business  establishment  ii 
steadily  increasing. 

It  is  a  matter  of  common  observation  that  to  launch  a 
business  to-day  a  larger  capital  is  required  than  was  the 
case  a  generation  ago.  An  examination  of  the  census 
statistics  of  manufactures  shows  us  how  strongly  marked 
this  tendency  toward  larger  establishments  has  become. 
From  1880  to  1905  the  number  of  estabUshments  mak- 
ing agricultural  implements  decreased  from  1943  to  648, 
while  the  aggregate  capital  of  the  industry  increased  from 
$62,000,000  to  $196,000,000.-  The  following  table  illus- 
trates the  same  tendency  in  other  industries:  — 


1880 

1880 

1905 

1905 

Number  of 
Establishments 

Capital 

Number  of 
Establishments 

Capital 

Boots  and  Shoes  . 

4,959 

$42,000,000 

i,3'6 

$96,000,000 

Chemicals  .     .     . 

595 

28,000,000 

448 

119,000,000 

Furniture    .     .     . 

5,227 

44,000,000 

2,482 

1 52,000,000 

Iron  and  Steel 

1,005 

230,000,000 

605 

936,000,000 

Lumber .... 

25.758 

1 8 1 ,000,000 

19,127 

5  1 7,000,000 

In  many  other  industries,  while  the  number  of  establish- 
ments increased  during  this  period,  the  capital  increased  far 
more  rapidly.  The  number  of  establishments  making  cotton 
goods  increased  from  1005  to  1 1 54,  but  the  capital  increased 
from  $219,000,000  to  $613,000,000.  Silk  manufacturing 
establishments  increased  from  382  to  624 ;  their  aggregate 
capital  increased  from  $19,000,000  to  $109,000,000.     There 


121 


122  INTRODUCTION   TO   ECONOMICS 

is  hardly  a  single  branch  of  manufacture  in  which  the 
average  establishment  has  not  increased  in  size  very 
markedly.  The  same  thing  is  true  even  in  greater  degree 
in  the  business  of  transportation,  both  by  rail  and  by 
water.  In  retail  and  wholesale  trade,  in  banking,  and  in 
insurance,  we  find  the  same  general  tendency  toward  an 
enlarging  business  unit.  The  present  may  therefore  justly 
be  characterized  as  an  era  of  business  concentration. 

In  order  to  understand  this  tendency,  we  must  acquaint 
ourselves  (i)  with  the  external  conditions  making  large 
scale  business  possible,  and  (2)  with  the  advantages  that 
enable  the  large  business  enterprise  to  prevail  in  competi- 
tion with  the  smaller  one. 

2.  TJic  size  of  a  business  is  dependent  upon  the  facilities 
for  assembling  I'aiv  material. 

Among  the  industries  showing  least  tendency  toward 
increase  in  the  size  of  the  individual  establishment  is  that 
of  canning  and  preserving  fruits  and  vegetables.  In  1880 
the  average  capital  of  an  establishment  engaged  in  this 
industry  was  $20,000;  in  1905  it  was  $21,000.  A  cannery 
must  depend  for  its  material  upon  the  products  of  a  rela- 
tively small  area,  since  fresh  fruits  and  vegetables  cannot 
be  carried  far  without  deterioration,  except  at  great  expense 
for  packing  and  icing.  The  size  of  an  establishment  for 
the  making  of  butter  and  pheese  suffers  under  the  same 
limitations.  The  same  thing  was  formerly  true  of  the 
slaughtering  of  cattle  and  swine ;  but  in  these  industries 
a  radical  change  has  occurred  in  recent  years. 

For  an  analogous  reason  no  marked  tendency  toward 
concentration  has  appeared  in  agriculture.  In  that  indus- 
try, an  important  element  in  success  consists  in  keeping 
the  dwelling  place  of  the  laborers  so  near  to  the  fields  that 
no  great  amount  of  time  is  wasted  in  going  to  and  from 
the  work.  It  is  also  essential  that  the  barns  and  granaries 
be  rear  enough  to  ^he  fields  to  obviate  excessively  long 


THE   CONCENTRATION    OF   INDUSTRY  123 

haulage  of  the  products.  It  follows,  then,  that  the  num- 
ber of  acres  that  may  be  managed  from  a  common  center 
is  somewhat  narrowly  limited.  An  apparent  exception  to 
this  rule  is  to.  be  found  in  the  great  wheat  farms  of  Cali- 
fornia, the  Dakotas,  and  the  Canadian  Northwest.  Here 
the  land  is  level  and  free  from  stones  and  stumps  of  trees  ; 
the  natural  fertility  is  great,  and  evenly  distributed  over 
large  areas.  Cultivation  consists  simply  in  plowing,  sow- 
ing, and  harvesting,  and  this  can  be  done  by  aid  of  the 
highest  type  of  agricultural  machinery.  As  soon  as  the 
natural  fertility  of  the  soil  is  exhausted,  however,  a  more 
intensive  tillage  will  be  necessary ;  fertilizers  will  have 
to  be  applied ;  rotation  of  crops  will  succeed  continuous 
wheat-cropping.  For  such  tillage  the  immense  unbroken 
fields  are  not  well  adapted.  The  "bonanza"  farm  is  a 
transient  as  well  as  an  exceptional  phenomenon. 

3.  TJie  size  of  the  business  wiit  is  fiirtJier  dependent  upon 
the  facilities  for  marketing  products. 

Some  products  deteriorate  so  rapidly  that  they  cannot 
be  produced  in  large  masses  and  distributed  over  wide 
areas.  Bakers'  bread  will  serve  as  an  example  of  this  type 
of  commodity.  It  would  be  useless  to  erect  a  bakery  so 
large  that  it  could  not  find  a  sufificient  market  for  its  wares 
within  easy  delivery  distance.  The  production  of  many 
kinds  of  fresh  fruits  and  vegetables  is  similarly  dependent 
on  a  local  clientele  for  a  market,  and  the  size  of  the  estab- 
lishment is  Umited  accordingly.  Some  products  are  limited 
to  a  narrow  local  market  because  they  are  too  bulky  to 
justify  transportation  over  long  distances.  Common  bricks 
and  firewood  fall  in  this  class.  In  both  classes,  the  denser 
the  population,  the  larger  the  business  establishment  that 
can  be  successfully  operated. 

4.  Every  iinpro-ocment  in  transportation  and  reduction  of 
charges  makes  possible  an  increase  in  the  size  of  the  average 
business  establishment. 


124  INTRODUCTION   TO   ECONOMICS 

Reduction  in  the  charges  for  carrying  wheat  and  flour, 
both  by  rail  and  by  water,  have  resulted  in  an  extraordinary 
concentration  of  the  business  of  grinding  grain.  The 
average  flour  and  grist  mill  in  1880  had  a  capital  of 
$'j2$o;  in  1905,  the  average  capital  was  $26,500.  In 
Minnesota,  the  chief  center  of  the  industry,  the  average 
capital  is  nearly  $100,000. 

Low  rates  on  stock  cars,  and  the  development  of  the 
refrigerator  car  and  refrigerator  storage  on  shipboard, 
have  made  possible  the  centralization  of  the  slaughtering 
business.  Reductions  in  the  rates  on  furniture  have 
enabled  Michigan  furniture  makers  to  send  their  goods  to 
the  most  distant  parts  of  the  United  States.  There  is 
scarcely  a  single  manufacturing  enterprise  in  the  United 
States  which  has  not  been  brought  within  reach  of  a  wider 
market  by  the  recent  progress  in  transportation. 

Mercantile  establishments  find  their  sphere  enlarged  in 
similar  manner.  Rapid  transit  for  passengers,  and  the 
advent  of  the  motor  delivery  wagon,  have  enabled  many 
retail  stores  to  expand  far  beyond  the  requirements  of  the 
territory  they  originally  served.  The  adoption  by  the 
United  States  of  a  parcels  post  system  similar  to  that  of 
European  countries,  would  enable  many  "  mail  order " 
stores  to  extend  their  business  much  beyond  its  present 
limits. 

5.  Where  industry  is  carried  on  by  individual  entej'pris- 
ers,  business  concentration  depends  upon  the  concentration  of 
wealth. 

Before  the  middle  of  the  nineteenth  century  the  typical 
business  enterprise,  both  in  the  United  States  and  in 
foreign  countries,  was  owned  by  a  single  individual  or  by 
a  partnership  consisting  of  a  small  number  of  individuals. 
Large  scale  enterprise,  then,  was  possible  only  where 
comparatively  few  had  gained  possession  of  large  fortunes. 
In  countries  where  there  was  little  inequality  in  wealth, 


THE   CONCENTRATION   OF   INDUSTRY  125 

as  in  France,  the  concentration  of  business  could  not  be 
so  marked  as  in  countries  where  inequalities  were  greater, 
as  in  England.  In  the  newer  and  more  democratic  parts 
of  the  United  States,  enterprise  was  conducted  on  a 
smaller  scale  than  in  the  older  parts,  where  wealth  had 
been  accumulated  in  fewer  hands. 

6.  TJic  corporate  form  of  business  organization  makes 
possible  a  higher  degree  of  concentration  than  is  possible 
under  a  system  of  individual  enterprise. 

A  business  corporation,  or  joint  stock  company,  is  an 
association  of  individuals  authorized  by  government  to 
carry  on  an  enterprise  and  endowed  with  certain  special 
privileges,  the  most  important  of  which  is  the  right  to  be 
treated  in  law  as  a  single  person.  Members  of  the  asso- 
ciation are  such  by  virtue  of  ownership  of  shares  of  stock 
in  the  corporation.  In  the  simplest  form  of  corporation 
all  shares  of  stock  represent  equal  shares  in  the  control 
of  the  corporation  and  equal  claims  upon  its  profits.  The 
stockholders  elect  a  board  of  directors  and  other  impor- 
tant officers;  employees  of  minor  rank  are  usually  ap- 
pointed by  the  president,  or  by  the  president  and  directors. 
All  business  of  the  corporation  is  carried  on  by  its  officers 
and  employees ;  shareholders,  as  such,  cannot  engage  in 
business  in  the  name  of  the  corporation. 

When  a  member  of  a  non-corporate  business  association, 
or  partnership,  dies  or  withdraws  from  the  business,  it  is 
necessary  to  wind  up  the  affairs  of  the  association.  When 
a  holder  of  stock  in  a  corporation  dies,  his  shares  descend 
to  his  heirs,  like  any  other  personal  property ;  when 
he  wishes  to  withdraw  from  the  corporation,  he  merely 
sells  his  shares.  Changes  in  the  personnel  of  the  stock- 
holders do  not  affect  the  business  of  the  corporation. 
Therein  lies  the  great  superiority  of  the  corporation  over 
partnership  associations.  The  former,  when  not  limited 
by  law,  has  perpetual  life,  and  can   therefore  undertake 


126  INTRODUCTION   TO   ECONOMICS 

policies  looking  to  distant  gains ;  the  partnership,  on  the 
other  hand,  is  subject  to  dissolution  at  any  time,  and  is 
therefore  unsuited  to  large  and  permanent  enterprises. 

Wherever  the  corporate  form  of  organization  is  well 
established,  large  enterprises  become  possible  even  in 
communities  where  there  are  no  individuals  possessing 
great  wealth.  A  steel  plant  requiring  an  investment  of 
^6,000,000  may  be  erected  in  a  city  where  no  man  has 
more  than  $10,000  to  invest.  Capital  secured  from  a 
thousand  different  persons  thus  acquires  the  same  effec- 
tiveness as  a  vast  capital  owned  by  a  single   individual. 

The  corporate  form  of  organization  is  to-day  the  pre- 
vailing form  in  the  United  States.  Corporations  produced 
73.7  per  cent  of  the  manufactures  of  the  United  States  in 
the  year  1905.  Individual  and  partnership  enterprises 
were  indeed  far  more  numerous  than  corporations,  repre- 
senting 74.9  per  cent  of  all  enterprises.  But  the  establish- 
ments thus  organized  are,  as  a  rule,  small  ones,  and  are 
of  dwindling  importance  in  the  nation's  industry. 

Having  gained  an  insight  into  the  conditions  under 
which  business  concentration  is  possible,  we  may  proceed 
to  a  consideration  of  the  advantages  which  the  large  es- 
tablishment enjoys. 

7.  The  large  cstablisJimeiit  can  make  the  most  extensive 
use  of  the  principle  of  division  of  labor. 

As  we  saw  in  the  last  chapter,  manifold  advantages 
spring  from  the  division  of  labor.  The  establishment  to 
be  launched  must  be  at  least  large  enough  to  make  the 
fullest  practicable  use  of  this  principle.  Perhaps  this  end 
would  be  attained,  so  far  as  the  working  force  directly 
engaged  in  the  process  of  manufacture  is  concerned,  in 
an  establishment  with  a  capital  of  $100,000  and  with  100 
laborers.  A  second  100  laborers,  supplied  with  an  equal 
amount  of  capital,  might  double  the  output,  but  they 
would  not  increase  the  efficiency  of  the  first  hundred  men. 


THE   CONCENTRATION   OF   INDUSTRY  127 

So  with  a   third  and  fourth    hundred    men.     No  further 
economy  in  concentration  arises  under  this  head. 

In  addition  to  its  manual  laborers,  the  establishment 
must  have  an  "office"  force;  possibly  it  may  have  buying 
agents,  who  travel  long  distances  in  search  of  the  various 
materials,  and  selling  agents,  likewise  compelled  to  travel 
about  in  search  of  buyers.  A  small  establishment  could 
support  only  a  small  number  -of  employees  of  these 
classes ;  there  could  be  no  extended  division  of  labor 
among  them.  An  establishment  of  larger  size  might  be 
able  to  assign  one  man  exclusively  to  the  purchase  of  one 
kind  of  material,  another  to  the  purchase  of  another  kind, 
and  so  enjoy  the  advantages  of  specialized  skill.  Similar 
division  of  labor  might  be  effected  among  the  selling 
agents  and  among  the  members  of  the  office  force.  In 
this  way  a  very  large  establishment  could  assure  itself 
that  every  commercial  situation  arising  would  receive  ex- 
pert attention.  There  is,  of  course,  no  theoretical  limit 
to  the  possible  gains  from  this  source.  An  establishment 
might  be  so  large  that  it  could  have  a  man  devoting  his 
full  time  to  the  purchase  of  machine  oil  for  its  use,  and 
something  would  doubtless  be  gained  through  the  skill  he 
would  develop.  But  in  practical  life  such  trifling  gains 
would  have  little  effect  in  determining  the  size  of  an  estab- 
lishment. They  are  too  small  to  make  a  perceptible  addi- 
tion to  dividends. 

8.  /;/  tJie  large  establishment  it  is  possible  to  make  7ise 
of  the  most  perfect  mccJianieal  eqiiipmeiit. 

The  process  of  manufacture  may  involve  a  score  or 
more  of  manipulations  of  the  material,  and  at  each  stage 
several  machines  may  be  drawn  into  use.  A  number  of 
different  types  of  machinery  are  on  the  market,  some  per- 
forming the  function  required  with  greater  celerity  and 
certainty  than  others.  The  better  machines,  naturally,  rep- 
resent a  larger  investment.    To  equip  a  factory  throughout 


128  INTRODUCTION   TO   ECONOMICS 

with  the  best  machinery  would  require  a  large  capital, 
even  if  the  process  could  be  reduced  to  a  series  of  steps 
occupying  one  set  of  machines  as  long  as  another.  Such 
a  division  of  the  process  is  not  ordinarily  practicable ;  some 
machines  contribute  only  very  slight  changes  in  the  material, 
delaying  it  but  a  moment  as  it  passes  through,  while  other 
machines  subject  the  material  to  more  important  changes 
and  delay  it  for  a  longer  period.  In  order  that  the  machines 
may  all  be  used  to  their  full  capacity,  there  must  be  a  num- 
ber of  machines  engaged  in  the  slower  parts  of  the  process 
to  one  engaged  in  the  part  which  can  be  performed  quickly. 
And  this  involves  a  still  further  increase  in  the  capital  of 
the  establishment. 

In  most  industries,  the  general  progress  of  invention  is 
in  the  direction  of  more  costly  machines,  and  this  is  one  of 
the  more  important  reasons  for  the  trend  toward  industrial 
concentration.  At  a  particular  time,  however,  there  is  a 
theoretical  size  of  business  which  permits  full  equipment 
with  the  best  machines  then  available.  An  increase  in  the 
establishment  beyond  this  point  brings  no  advantage  in 
the  direct  process  of  manufacture.  There  may,  however, 
be  other  important  advantages  to  be  gained  through  such 
enlargement  of  plant. 

9.  The  large  establisJiment  enjoys  the  advantage  of  cheap 
power. 

The  providing  of  power,  in  most  manufacturing  indus- 
tries, is  one  of  the  most  important  of  technical  problems, 
and  here  the  large  establishment  usually  has  decided  ad- 
vantages. The  larger  the  power  plant,  in  general,  the 
cheaper  can  power  be  furnished.  There  is  not  so  much 
heat  wasted  in  a  large  furnace  as  in  a  small  one ;  a  large 
power  plant  can  be  so  arranged  as  to  prevent  much  of  the 
waste  of  power  in  transmission  that  usually  takes  place  in 
a  small  establishment.  Here  it  would  be  difficult  to  'find  a 
theoretical  Hmit  to  the  advantages  that  follow  from  an  in- 


THE   CONCENTRATION   OF   INDUSTRY 


i2g 


crease  in  size  of  plant.  In  practice,  however,  the  econo- 
mies to  be  gained  in  this  way  are  not  very  important  after 
a  moderate  size  of  plant  has  been  reached.  We  do  not 
find  men  constructing  huge  factories  merely  to  obtain  the 
advantages  of  cheaper  power,  although  these  advantages 
may  not  be  entirely  neglected  in  determining  the  size  of  a 
business  to  be  established. 

10.  The  large  establishment  zvastes  less  material  than 
the  small  one. 

In  the  early  history  of  the  American  iron  industry  the 
waste  of  fuel  and  metal  was  enormous.  Present-day  iron 
manufacturers  find  it  worth  while  to  resmelt  the  masses  of 
slag  left  as  worthless  by  the  early  smelters.  The  increase 
in  the  size  of  the  blast  furnace  has  reduced  by  over  fifty  per 
cent  the  amount  of  fuel  necessary  to  produce  a  ton  of  pig 
iron.  The  wastefulness  of  small  scale  industry  is  strikingly 
illustrated  in  gold  production.  In  one  gold  mining  district 
of  Mexico  it  is  estimated  that  $  120,000,000  worth  of  metal 
has  gone  down  into  the  streams  in  the  mud  and  sand  from 
which  the  gold  is  washed.  Modern  large-scale  methods 
would  have  recovered  practically  all  of  this  gold. 

Furthermore,  much  material  which  would  be  absolutely 
useless  to  the  small  producer  is  made  to  yield  a  profit  to 
the  large  enterprise  which  is  adeqirately  provided  with 
equipment.  On  the  Snake  River  in  Oregon  are  large 
deposits  of  gold-bearing  gravel,  but  the  amount  of  gold 
contained  in  the  gravel  —  about  twenty  cents  per  cubic 
yard — would  not  pay  the  small  producer  for  the  trouble 
of  getting  it.  A  gold-dredging  enterprise  has  secured  an 
enormous  profit  —  in  one  year,  128  per  cent  on  its  capital 
—  from  this  gold  deposit. 

11.  The  large  enterprise  can  often  utilize,  for  by-products^ 
what  the  small  enterprise  rejects  as  zvastc. 

In  almost  every  industry  the  material  undergoes  some 
shrinkage    in    the   process   of    manufacture,  through    the 


130 


INTRODUCTION   TO   ECONOMICS 


removal  of  parts  not  fitted  to  enter  into  the  main  product 
These  parts  are  waste  in  a  small  establishment,  and  the 
problem  of  getting  rid  of  them  is  often  a  serious  one.  In 
the  large  establishment  they  accumulate  in  enormous 
quantities,  and  the  question  whether  they  could  not  be 
utilized  in  some  way  readily  suggests  itself.  Through  suc- 
cessive experiments,  one  element  after  another  ceases  to 
figure  as  waste,  and  is  transformed  into  a  by-product. 
Thus  forty  years  ago  much  of  the  residue  of  the  small  oil 
refineries  was  allowed  to  flow  away  in  the  streams.  The 
same  material  to-day  is  the  basis  of  scores  of  by-products, 
the  value  of  which  is  an  important  element  in  the  profits 
of  the  petroleum  industry.  Compare  the  methods  of  waste 
disposal  of  the  small  butcher  shops  of  to-day  with  those  of 
the  great  packing  houses.  To  the  former  from  forty  to 
sixty  per  cent  of  every  animal  slaughtered  is  sheer  waste, 
to  be  got  rid  of  in  whatever  way  the  public  health  authori- 
ties will  permit.  This  waste  in  the  large  establishment  is 
transformed  into  over  a  hundred  by-products,  practically 
no  part  of  it  being  considered  wholly  valueless.  Such 
utilization  of  waste  requires  the  investment  of  a  consider- 
able capital  in  various  kinds  of  appliances  and  the  employ- 
ment of  a  large  body  of  laborers  who  have  nothing  to  do 
with  the  main  proc^uct.  Some  of  the  by-products  take 
from  the  mass  of  waste  only  insignificant  elements ;  hence 
their  utilization  is  possible  only  when  waste  accumulates 
in  enormous  quantities.  It  is  obvious  that  only  a  very 
large  establishment  can  carry  on  a  thoroughly  systematic 
plan  of  developing  by-products.  An  establishment  large 
enough  to  enjoy  all  the  advantages  of  division  of  labor 
and  of  costly  machinery  may  not  be  one  tenth  large 
enough  to  gain  all  the  profits  of  waste  utilization. 

12.  TJie  large  establishment  can  secure  materials  at  lower 
prices,  and  sell  its  products  at  higJier  prices,  than  is  possible 
for  the  small  establishment. 


THE    CON'CENTRATION    OF    INDUSTRY  131 

It  has  already  been  pointed  out  that  an  important  ad- 
vantage of  the  large  establishment  is  the  possibility  of  or- 
ganizing its  buying  and  selling  agents  in  such  a  way  as  to 
develop  special  skill  for  each  kind  of  transaction.  A  further 
commercial  advantage  consists  in  the  fact  that  purchases 
can  be  made  on  a  large  scale,  and  therefore,  generally, 
on  especially  favorable  terms.  The  dealer  in  raw  material 
can  afford  to  sell  at  an  unusually  low  price  to  a  customer 
whose  purchases  may  mount  up  into  millions.  The  same 
thing  is  true  of  all  other  dealers  who  supply  the  large 
establishment.  There  may,  indeed,  be  a  combination 
among  such  dealers,  fixing  the  margin  of  profit  at  which 
each  must  sell;  but  such  a  combination  can  do  little  toward 
extorting  high  profits  from  an  enterpriser  who  can,  if  he 
chooses,  dispense  with  the  middleman  altogether,  and  deal 
directly  with  the  producer  of  the  materials.  The  maker 
of  machinery  is  likewise  compelled  to  content  himself  with 
a  small  profit  when  dealing  with  a  concern  which  has  capi- 
tal and  enterprise  enough  to  make  its  own  machinery,  if 
it  finds  a  profit  in  so  doing.  In  its  sales,  the  large  es- 
tablishment enjoys  similar  advantages.  It  can  provide 
each  purchaser  with  such  quantities  and  such  qualities  as 
he  may  desire.  If  part  of  the  product  is  to  be  exported, 
the  large  establishment  can  afford  to  send  agents  to  foreign 
countries  to  find  out  what  qualities  are  desired,  and  in  what 
form  the  product  will  be  most  acceptable  to  the  foreign 
taste. 

The  large  enterpriser,  further,  can  make  a  more  sys- 
tematic study  of  the  market  than  can  the  smaller  one,  and 
so  can  make  his  purchases  and  sales  when  the  markets 
are  most  favorable. 

13.  TJie  lai'ge  establisJimetit  often  enjoys  exceptionally  lou 
rates  on  its  shipments. 

Since  the  large  enterprise  commonly  secures  its  supplies, 
and   ships  its   products,   in  large  quantities,  it  can  more 


132 


INTRODUCTION   TO   ECONOMICS 


frequently  avail  itself  of  the  low  rates  on  carload  lots  than 
can  its  smaller  competitors.  More  important  still,  it  can 
often  force  railway  and  steamship  companies  to  discrimi- 
nate in  its  favor  in  fixing  charges.  Formerly  this  was 
done  openly.  When  laws  were  passed  forbidding  discrimi- 
nating rates,  the  large  enterprise  was  given  secret  rebates, 
which  often  represented  a  very  material  reduction  in  rates. 
This  practice,  it  is  believed,  is  not  so  common  as  it  was 
some  years  ago.  Whether  this  is  true  or  not,  there  can  be 
little  doubt  that  in  the  past  railway  discriminations  have 
played  an  important  part  in  hastening  the  concentration 
of  industry. 

14.  The  large  enterprise  usually  pays  a  lozver  rate  of 
interest  on  loans  tJia)i  the  small  enterprise. 

No  matter  how  large  the  capital  of  an  enterprise  may 
be,  there  will  at  times  be  need  of  borrowing  money.  At  a 
particular  time  the  market  for  materials  may  be  so  favor- 
able that  it  will  be  profitable  to  purchase  large  supplies 
beyond  current  needs.  An  active  business  will  not  have 
on  hand  any  large  amount  of  idle  cash ;  hence  the  neces- 
sity for  borrowing.  As  a  rule,  bankers  lend  money  at  a 
lower  interest  rate  to  a  large  enterpriser  than  to  a  small 
one.  The  principal  reason  why  they  do  this  is  that  the 
large  establishment  appears  to  offer  better  security  than 
the  small  one. 

15.  TJie  advantages  of  business  concentration  vary  in 
their  nature  from  industry  to  industry. 

The  foregoing  is  of  course  very  far  from  an  exhaustive 
statement  of  the  advantages  of  the  large  enterprise  as 
compared  with  the  small  one.  Other  advantages  will 
readily  occur  to  any  one  who  observes  the  economic  de- 
velopment of  the  locality  in  which  he  lives.  It  will  be 
observed  that  some  of  the  advantages  are  prominent  in 
one  industry,  some  in  another.  In  the  manufacture  of 
cotton    cloth,    for   example,   there    are    no   important   by- 


THE   CONCENTRATION    OF    INDUSTRY  133 

products  to  be  utilized.  The  market  for  ordinary  grades 
of  cloth  is  well  developed ;  the  jobber  takes  the  product 
from  the  manufacturer's  hands  and  disposes  of  it  to  the 
retailer,  charging  a  commission  so  low  that  it  would  hardly 
pay  the  manufacturer  to  dev^elop  selling  agencies  of  his 
own.  Neither  the  material  nor  the  product  is  very  bulky, 
in  comparison  with  its  value  ;  hence  the  advantages  en- 
joyed by  the  large  concern  in  the  matter  of  freight  trans- 
portation are  not  likely  to  be  of  very  great  importance. 
To  equip  a  mill  thoroughly  with  the  best  machinery  in  the 
market  does  not  require  a  very  large  capital ;  nor  does  an 
establishment  have  to  be  very  large  to  enjoy  to  the  full  the 
advantages  of  division  of  labor.  Certain  advantages  do 
indeed  attend  mere  size,  even  in  this  industry  ;  but  they 
are  not  so  important  that  they  may  not  be  counterbalanced 
by  slightly  better  management  on  the  part  of  the  smaller 
establishment. 

In  the  iron  and  steel  industries,  on  the  other  hand,  a 
complete  equipment  of  machinery  is  usually  very  costly. 
A  large  capital  is  required  to  keep  every  important 
machine  i-n  constant  use.  The  transportation  of  materials 
and  products  is  expensive,  and  a  great  part  of  the  profit  of 
an  establishment  may  depend  upon  the  kind  of  contract 
that  can  be  made  with  the  transportation  companies.  By- 
products are  not  very  important,  but  the  larger  establish- 
ment can  secure  large  economies  through  making  the 
best  use  of  its  material.  Fuel  is  of  course  an  immensely 
important  item  in  the  industry,  and  decided  advantages 
are  to  be  obtained  through  purchases  on  a  large  scale. 
Furthermore,  the  larger  the  establishment  the  greater  the 
economy  possible  in  the  use  of  the  fuel.  Accordingly,  in 
this  industry  a  very  large  plant  will  have  substantial 
advantages  over  one  of  moderate  size.  In  the  meat  pack- 
ing industry,  so  far  as  the  use  of  machinery  is  concerned, 
there  is  no  important  advantage  enjoyed  by  the  very  large 


134 


INTRODUCTION   TO   ECONOMICS 


plant  of  which  a  plant  of  moderate  size  could  not  avail 
itself.  Economy  of  fuel  is  another  minor  consideration  in 
this  industry.  The  important  advantages  of  the  large 
plant  consist  in  more  systematic  division  of  labor,  better 
utilization  of  by-products,  better  conditions  of  transporta- 
tion, and  more  effective  advertising.  In  the  refining  of 
petroleum,  almost  every  form  of  advantage  that  has  been 
mentioned  favors  the  large  establishment. 

It  is  not  to  be  inferred  that  the  advantages  of  the  large 
establishment  are  confined  to  manufacturing  industry. 
Mercantile  business  shows  much  the  same  tendency  to- 
ward concentration.  In  the  retail  trade,  the  large  estab- 
lishment enjoys  great  advantages  in  the  purchase  and  sale 
of  goods;  it  not  only  buys  more  cheaply,  but  it  is  better 
able  to  cater  to  the  tastes  of  its  customers  than  the  small 
store.  It  can  afford  a  style  of  advertising  that  reaches  the 
public,  while  the  small  establishment  is  likely  to  throw 
away  the  money  it  spends  in  advertising,  not  succeeding  in 
impressing  the  conviction  of  its  merits  upon  the  prospective 
customer. 

16.  TJie  gains  from  concentration  arc  subject  to  a  lazv  of 
dim  in  isJi  ing  retn  rns. 

Theoretically  it  is  difficult  to  establish  a  point  beyond 
which  further  enlargement  of  a  business  establishment 
would  be  unprofitable.  Every  enlargement  of  a  petroleum 
refinery,  for  example,  makes  possible  some  new  economies. 
After  a  certain  size  has  been  reached,  however,  an  estab- 
lishment is  able  to  enjoy  most  of  the  known  advantages  of 
large  scale  production.  In  some  industries,  this  involves 
an  investment  of  $500,000;  in  other  industries,  perhaps,  of 
1^50,000,000.  A  capital  of  such  size  the  enterpriser  will 
vigorously  strive  to  bring  together.  A  profitable  business 
may  perhaps  be  conducted  with  a  much  smaller  capital; 
but  it  will  be  more  and  more  seriously  handicapped  as  time 
passes,  and  the  average  size  of  new  competing  establish- 
ments increases. 


THE   CONCENTRATION    OF   INDUSTRY  135 

There  is  of  course  no  reason  why  an  establishment 
should  not  be  much  larger  than  is  necessary  to  obtain 
practically  all  the  benefits  of  large  scale  production  known 
at  the  time.  Say  that  a  $2,000,000  plant  offers  all  these 
advantages,  there  is  no  reason  why  a  $4,000,000  or  a 
$6,000,000  plant  should  not  be  established.  But  capital 
cannot  be  got  together  without  effort;  and  unless  substan- 
tial advantages  are  to  be  gained  through  the  larger  in- 
vestment, the  enterpriser  is  likely  to  rest  content  with  the 
smaller  one. 

As  we  have  seen,  the  expansion  of  businesses  already 
established,  in  whatever  branch  of  industry,  is  confined  to 
narrow  limits  by  the  law  of  diminishing  returns.  There  is 
a  similar  law  which  confines  within  narrow  limits  the  size 
of  a  new  enterprise  in  aii  industry  dependent  upon  local 
supplies  of  material,  or  a  local  market  for  its  products. 
With  such  enterprises,  a  point  is  reached  where  increasing 
business  is  attended  by  increasing  cost,  transportation  gen- 
erally representing  the  expanding  element  in  cost.  Finally, 
we  have  the  new  enterprises  in  industries  which  are  prac- 
tically independent  of  local  supplies  of  material  and  of  the 
local  demand  for  products.  In  these  enterprises  we  may 
assume  that  no  element  in  production  is  as  yet  fixed. 
They  may,  within  limits,  assume  such  magnitude  as  will 
give  them  command  over  all  the  economies  of  large  scale 
production.  These  economies  have  a  determining  impor- 
tance in  the  choice  between  a  small  business  and  one  of 
moderate  size;  they  are  of  less  importance  in  the  choice 
between  an  establishment  of  moderate  size  and  a  large 
one;  with  further  increase  in  size  of  establishment  their 
importance  dwindles.  Perhaps  there  is  no  point  at  which 
further  economies  cease;  but  there  is  a  point  at  which  they 
cease  to  be  of  practical  importance.  In  economic  lan- 
guage, the  economies  from  concentration  of  industry  are 
subject  to  a  law  of  diminishing  returns. 


136  INTRODUCTION   TO   ECONOMICS 

17.    Summary. 

Concentration,  or  increase  in  size  of  the  business  estab- 
lishment, is  a  characteristic  of  the  existing  stage  of  eco- 
nomic development.  A  partial  explanation  of  concentration 
is  to  be  found  in  improvements  in  transportation,  which 
make  possible  the  assembling  of  raw  material  and  the 
marketing  of  finished  products.  A  prerequisite  of  con- 
centration is  the  control  of.  great  wealth  by  single  enter- 
prisers. Such  control  may  result  either  from  the  growth 
of  large  fortunes  or  from  the  adoption  of  the  corporate 
form  of  business  organization. 

The  advantages  of  large-scale  production  are:  (i)  more 
thoroughly  systematized  division  of  labor;  (2)  better  me- 
chanical equipment ;  (3)  cheaper  power;  (4)  utilization  of 
waste;  (5)  lower  prices  for  materials  and  higher  prices  for 
finished  products ;  (6)  lower  charges  for  transportation  ; 
(7)  lower  interest  rates.  All  these  advantages  are  subject 
to  a  law  of  diminishing  returns. 


CHAPTER    IX 
BUSINESS    COMBINATIONS 

1.  /;/  viaiiy  branches  of  trade  and  i)idiistry  the  several 
establisJimoits  are  forniiiig  eouibinations  that  /ijuit  in  greater 
or  less  degree  the  independence  of  action  of  each  one. 

In  the  last  chapter  we  saw  that  the  average  industrial 
establishment  is  steadily  increasing  in  size.  In  some  in- 
dustries concentration  has  already  gone  so  far  that  a  small 
number  .of  establishments  control  the  greater  part  of  the 
output.  A  movement  that  is  even  more  striking  than 
the  concentration  of  industry  is  the  formation  of  combina- 
tions among  the  enterprisers  controlling  an  industry.  This 
movement  is,  in  part,  a  direct  result  of  concentration. 
When  the  number  of  producers  becomes  small,  it  is  rela- 
tively a  simple  matter  to  unite  them  for  a  common  purpose. 
The  tendency  toward  combination  is,  however,  not  a  neces- 
sary result  of  concentration ;  we  may  therefore  best  treat 
the  two  movements  separately. 

Combinations  are  most  frequent  in  the  fields  of  trans- 
portation and  manufacture.  Most  of  the  railways  of  the 
country  are  combined  in  a  few  great  systems ;  most  of  the 
manufacture  of  steel  is  controlled  by  half  a  dozen  great 
combinations,  and  the  same  thing  is  true  of  illuminating 
oil,  tin  plate,  sugar,  and  a  great  variety  of  other  industries. 
The  production  of  copper  and  the  smelting  of  silver  and 
gold-bearing  ores  is  largely  controlled  by  combinations.  A 
combination  of  great  capitalists  controls  the  mining  of 
anthracite  coal ;  in  some  parts  of  the  country  the  mining 
of  bituminous  coal  has  fallen  under  the  domination  of  com- 
binations.    Indeed,  we  may  say  that  the  tendency  toward 

137 


1-8  INTRODUCTION   TO    ECONOMICS 


'o 


combination  manifests  itself  in  practically  every  branch  of 
economic  life. 

2.  Combination  may  take  the  form  of  a  union  of  pro- 
ducers that,  as  independent  units,  would  be  in  active  competi- 
tion with  one  another. 

The  combinations  that  first  attracted  serious  attention 
in  the  United  States  were  organized  in  the  field  of  railway 
transportation.  Two  roads,  uniting  the  same  terminals,  in- 
stead of  competing  recklessly  for  business,  often  formed 
agreements  dividing  the  traffic  on  what  appeared  to  them 
an  equitable  basis.  In  most  of  the  early  industrial  combi- 
nations, the  members  forming  the  union  were  engaged  in 
the  same  stage  of  the  process  of  production,  and  hence 
were  active  competitors  until  the  combination  was.  formed. 
Such  were  the  steel  rail,  the  tin  plate,  and  the  wire  nail 
combinations  in  the  iron  and  steel  industries.  Similar  com- 
binations have  existed  among  the  paper  manufacturers,  the 
smelters  of  the  more  valuable  metals,  the  distillers,  and  the 
binding  twine  manufacturers.  It  is  associations  of  this 
kind  that  are  commonly  designated  by  the  term  combination. 

3.  Combination  may  assume  the  form  of  a  union  betzveen 
establisJiments  engaged  in  dijferent  stages  in  the  process  of 
producing  and  marketing  a  commodity. 

One  of  the  earlier  phases  in  economic  development  was 
the  distribution  of  the  various  stages  in  the  production  of 
a  commodity  among  a  number  of  industries  or  sub-indus- 
tries. The  manufacture  of  woolen  cloth  represented  sev- 
eral independent  industries :  washing  and  sorting  wool, 
carding  and  spinning,  weaving,  fulling,  dyeing.  The  dis- 
tribution of  the  product  to  the  various  consuming  centers 
gave  rise  to  another  independent  line  of  business,  the 
wholesale  trade.  The  work  of  placing  the  finished  product 
in  the  hands  of  the  consumer  was  taken  over  by  another 
business,  the  retail  trade. 

In    recent    years    an   opposing  tendency  has   made  its 


BUSINESS   COMBINATIONS  I3g 

appearance.  The  entire  work  of  preparing  and  distribu- 
ting a  commodity  is,  in  many  cases,  undertaken  in  a  com- 
bination of  establishments  representing  a  single  enterprise. 
One  company  mines  coal  and  iron  ore,  transports  these 
materials  in  its  own  ships  and  over  its  own  railways,  trans- 
forms the  materials  into  pig  iron  for  use  in  its  own  steel 
plant,  and  sells  the  finished  product — ^  rails,  structural  ma- 
terial, etc.  ^ — directly  to  the  final  purchaser.  There  are 
furniture  makers  that  advertise  the  fact  that  every  stage 
in  the  process  of  production,  from  the  felling  of  the  tree 
to  delivery  at  the  customer's  door,  is  under  their  control. 
Shoe  manufacturers  own  the  tanneries  that  supply  them 
with  material,  and  chains  of  retail  stores  that  place  the 
product  before  the  consumers.  This  uniting  of  all  the 
stages  in  the  process  of  production  in  one  combined  enter- 
prise is  known  as  the  integration  of  industry.  Integration 
and  combination  in  the  restricted  sense  often  go  hand  in 
hand.  The  United  States  Steel  Corporation  is  a  combina- 
tion of  producers  in  the  final  stage  in  production,  as  well 
as  a  combination  of  producers  in  different  stages  of  the 
process. 

4.    Some  combinatiojis  are  temporary  in  their  nature. 

Even  in  an  industry  which  is  apparently  so  unfavorable 
to  combination  as  agriculture,  temporary  combination  is 
becoming  fairly  common.  Farmers  often  combine  for  the 
purchase  of  machinery,  seed,  or  other  supplies,  or  for  the 
shipment  of  their  products  to  distant  markets.  Similarly, 
petty  retailers  combine  in  the  purchase  of  goods  from  the 
manufacturers,  thereby  gaining  the  benefits  of  purchasing 
in  large  quantities.  A  number  of  newspapers  often  unite 
in  sending  a  correspondent  to  a  war  or  other  center  of 
popular  attention.  Groups  of  financiers  often  form  combi- 
nations, known  as  "  syndicates,"  to  subscribe  a  loan  which 
would  tax  too  seriously  the  resources  of  any  one.  Combi- 
nation of  the  nature  here  described  is  often  termed  business 


I40  INTRODUCTION   TO   ECONOMICS 

cooperation.  It  is  to  be  carefully  distinguished  from  laboi 
cooperation,  a  system  under  which  the  laborers  seek  to  rid 
themselves  of  the  control  of  an  employer. 

Another  form  of  temporary  combination  has  for  its  pur- 
pose common  action  in  fixing  prices.  In  the  year  1908 
there  was  a  widespread  combination  among  cotton  pro- 
ducers with  the  object  of  holding  their  cotton  for  a  fixed 
price.  Competing  railways  frequently  agree  upon  charges 
for  a  limited  period  of  time.  Groups  of  speculators  often 
combine  to  force  up  the  prices  of  commodities  or  securities 
over  which  they  hold  a  temporary  control. 

5.  Some  combinations,  though  permanent  in  nature,  in- 
clude in  their  scope  only  a  s^nall part  of  the  activities  of  their 
several  members. 

In  many  parts  of  the  country  the  growers  of  fruit  have 
formed  associations  for  the  purpose  of  controlling  the 
marketing  of  products.  In  his  business  as  a  fruit  grower, 
each  member  of  the  combination  is  entirely  independent ; 
each  member  endeavors  to  excel  his  fellows  in  quantity 
and  quality  of  output.  Long  experience  of  the  exactions 
of  the  transportation  companies  and  the  commission  mer- 
chants has  led  to  united  action  in  the  marketing  of  products. 
Some  of  the  larger  associations  have  agents  who  visit  all 
the  important  consuming  centers  and  make  the  most  favor- 
able terms  with  the  merchants  who  deal  with  the  consumer. 
They  also  have  agents  whose  duty  it  is  to  watch  over  the 
movement  of  cars  bearing  the  products  of  the  association, 
and  to  take  note  of  the  condition  of  the  products  at  the 
time  of  delivery.  In  some  countries  dairymen  and  poultry 
producers  have  organized  similar  associations. 

Most  of  the  newspapers  of  the  country  are  combined  for 
the  purpose  of  gathering  news.  This  work  has  become 
so  complex  that  a  paper  which  cannot  avail  itself  of  the 
Associated  Press  dispatches  has  little  chance  of  survival. 
In  every  large  city  the  banks  maintain  a  clearing  house, 


BUSINESS   COMBINATIONS  141 

where  the  claims  of  the  various  banks  upon  one  another 
are  settled.  So  important  is  this  function  of  settlement 
that  a  bank  which  is  excluded  from  the  clearing  house  is 
seriously  handicapped  in  its  business.  In  some  German 
industries  the  several  establishments,  while  acting  independ- 
ently in  the  domestic  market,  maintain  common  agencies 
to  handle  the  export  trade. 

In  many  cases  in  American  industrial  history  attempts 
have  been  made  to  control  by  combination  the  aggregate 
output  of  an  industry,  and  so  to  fix  prices.  The  several 
enterprises  were  left  free  to  pursue  their  own  policies  in 
matters  of  production ;  in  matters  pertaining  to  the  mar- 
keting of  products  they  were  subject  to  the  control  of  the 
combination.  This  form  we  shall  consider  further  in  a 
later  section. 

6.  A  conibijiation  may  merge  the  several  establishments 
into  a  single  enterprise.  This  form  of  eombination  is  known 
as  a  consolidation. 

In  the  great  industrial  enterprises  of  to-day,  such  as 
the  United  States  Steel  Corporation,  the  Standard  Oil 
Company,  and  the  American  Sugar  Refining  Company, 
the  separate  establishments  have  completely  surrendered 
their  independence  of  action.  Each  establishment  has  its 
own  officers,  but  these  are  chosen  by  the  combination,  or 
"  parent "  corporation,  which  thus  determines  their  policy 
in  every  important  respect.  Several  hundred  combina- 
tions of  this  nature  have  been  organized  in  the  last  ten 
years.  So  important  are  these  combinations  that  many 
persons  beheve  that  the  days  of  individual  enterprise  in 
the  field  of  industry  are  numbered. 

7.  The  earliest  effective  form  of  permajient  combination 
for  pnrposes  of  price  control  zvas  the  "pool,''  an  agreement 
distributing  the  amount  of  busijiess  to  be  done,  or  the  receipts 
from  the  business,  among  the  several  enterprises. 

In  the  period  following  the  Civil  War  competition  be- 


142  INTRODUCTION   TO   ECONOMICS 

came  so  keen  in  many  lines  of  business  as  to  force  prices 
to  the  cost  level,  or  even  lower.  This  was  especially  the 
case  in  railway  transportation.  At  first  an  attempt  was 
made  to  maintain  rates  through  formal  agreements ;  but 
each  railway,  in  its  zeal  for  increased  business,  was  strongly 
impelled  to  cut  rates  in  spite  of  its  agreement  to  maintain 
them.  Various  devices  were  employed  to  restrain  this 
tendency  toward  cutting  rates.  The  most  successful  of 
these  were  the  "  pools."  A  number  of  railways,  com- 
peting for  traffic  between  two  centers,  would  agree  upon  a 
division  of  the  traffic  ("traffic  pools")  or  upon  a  division 
of  the  receipts  from  the  traffic  ("money  pools").  Thus 
in  1870  the  three  railways  connecting  Chicago  and  Omaha 
made  an  agreement  by  the  terms  of  which  each  road  was 
to  accept  whatever  through  business  was  offered,  at  a  rate 
set  by  mutual  agreement.  Each  road  was  to  retain  for 
itself  45  per  cent  of  the  earnings  of  the  through  passenger 
business  and  50  per  cent  of  the  earnings  of  the  through 
freight  business.  The  remainder  of  the  earnings  was  to 
be  placed  in  a  fund  to  be  shared  equally  by  the  three 
companies.  This  arrangement  remained  in  force  for  prac- 
tically fourteen  years ;  it  was  finally  destroyed  by  hostile 
legislation. 

A  similar  plan  was  adopted  by  the  Bessemer  Steel  Pool 
in  1896.  Each  mill  was  assigned  a  certain  percentage  of 
the  total  amount  of  steel  that  was  to  be  produced  by  the 
association.  If  any  mill  exceeded  its  allotment,  it  was  re- 
quired to  pay  $2  a  ton  on  the  excess  to  the  treasury  of  the 
association,  and  an  equal  sum  was  paid  to  those  members 
of  the  association  who  fell  short  of  their  allotted  output. 
In  this  way  a  restraint  was  placed  upon  the  more  active 
producers,  and  prices  were  maintained  at  a  decidedly 
profitable  level.  This  pool,  like  the  great  majority  that 
have  been  formed,  was  short-lived.  Some  of  the  more 
powerful  members  became  dissatisfied  with  the  percentage 


BUSINESS   COMBINATIONS  143 

of  output  allotted  to  them  and  withdrew,  leaving  the  pool 
too  weak  to  maintain  prices. 

8.  A  stronger  form  of  combination  was  created  by  placing 
a  majority  of  the  sJiares  of  stock  ijt  each  constituent  company 
permanently  in  the  hands  of  trustees.  This  form  of  com- 
bination is  kfiozvn  as  the  trust. 

In  1882  the  stockholders  of  the  leading  petroleum  refin- 
ing corporations,  which  had  for  many  years  operated  in  har- 
mony under  informal  agreements,  placed  a  majority  of 
their  stocks  in  the  hands  of  nine  trustees.  For  the  stock 
surrendered  to  .the  trustees,  the  owners  received  certificates 
entitling  them  to  shares  in  the  profits  of  the  combination. 
The  power  to  vote  the  stock  was  transferred  irrevocably 
to  the  trustees,  who  were  thus  in  a  position  to  determine 
the  policy  of  each  company.  This  form  of  organization 
was  adopted  by  several  other  powerful  combinations.  By 
a  federal  law  of  1890,  known  generally  as  the  Sherman 
Anti-Trust  Law,  the  trust  was  made  illegal,  so  far  as  it 
affected  interstate  commerce,  and  most  of  the  states  have 
passed  laws  prohibiting  trusts.  This  form  of  combination, 
therefore,  has  been  destroyed. 

9.  A  permanent  combination  may  be  established  through 
the  formation  of  a  corporation  for  the  purpose  of  securing 
control  of  a  majority  of  the  stock  in  each  of  the  companies 
which  it  is  sought  to  combine.  Such  a  corporation  is  prop- 
erly termed  a  holding  company ;  in  popular  speech  it  is 
called  a  "  trust.'' 

When  the  trust  form  of  organization  became  outlawed, 
men  who  sought  to  attain  the  same  end  hit  upon  the  de- 
vice of  organizing  a  corporation  with  power  to  purchase 
and  hold  the  stocks  of  other  companies.  The  laws  of 
several  states,  especially  those  of  New  Jersey,  are  very 
favorable  to  this  form  of  organization.  Accordingly,  when 
a  group  of  powerful  producers  desire  to  form  a  permanent 
combination,  they  secure  a  charter,  we  will  say  from  the 


144  INTRODUCTION   TO   ECONOMICS 

state  of  New  Jersey,  authorizing  the  formation  of  a  cor- 
poration with  extensive  powers,  including  the  essential  one 
of  holding  stocks  in  other  companies.  They  then  ex- 
change their  shares  in  the  business  corporations  which 
they  control  for  shares  in  the  new  company,  and  endeavor 
to  induce  other  persons  interested  in  the  same  industry  to 
do  likewise.  Or  the  new  corporation  may  place  its  shares 
on  the  market,  and  use  the  proceeds  in  the  purchase  of 
shares  of  producing  companies.  In  this  way  it  is  possible 
to  bring  a  large  part  of  an  industry  under  a  single  control. 
The  process  of  thus  merging  a  number  of  enterprises  into 
one  is  known  as  "consolidation." 

The  so-called  trusts  of  to-day  are  organized  in  the  way 
described  above.  In  some  cases  the  holding  company,  in- 
stead of  buying  shares  in  a  producing  company,  buys  its 
plant  outright.  In  many  cases  it  fails  to  secure  a  majority 
of  the  stock  in  such  a  company,  but  secures  a  sufficiently 
large  minority  of  stock  to  make  its  influence  decidedly  felt. 

10.  Consolidation  increases  the  productive  efficiency  of  the 
several  establisJnnents. 

Where  a  number  of  establishments  are  competing,  it  is 
to  the  interest  of  each  to  retain  exclusive  possession  of 
such  improvements  in  methods  as  it  may  succeed  in  mak- 
ing. If  an  improvement  consists  in  a  mechanical  inven- 
tion that  can  be  patented,  the  establishment  which  secures 
it  is  protected  in  its  monopoly  by  the  law.  It  is  conceiv- 
able that  each  one  of  a  score  of  competing  companies  may 
thus  retain  exclusive  possession  of  a  device  that  the  others 
could  use  to  advantage.  Consolidation  permits  each  com- 
pany to  make  use  of  all  the  patented  devices  originating 
in  the  establishments  of  the  other  companies. 

The  United  States  Steel  Corporation  is  at  present  erect- 
ing, at  Gary,  Indiana,  a  steel-making  plant  which  is  to  em- 
body every  idea  that  has  proved  profitable  in  any  of  the 
plants  of  the  company.      It  is  anticipated  that  steel  will 


BUSINESS    COMBINATIONS  145 

be  manufactured  more  cheaply  at  the  Gary  plant  than  is 
possible  in  any  existing  steel  works.  No  company  not 
having  the  combined  experience  of  the  Steel  Corporation 
could  hope  to  establish  a  plant  of  equal  efficiency. 

The  manager  of  one  out  of  a  number  of  competing 
establishments  knows  only  in  a  general  way  what  success 
his  rivals  are  enjoying.  One  establishment  may  produce 
steel  at  slightly  less  cost  than  another,  without  attracting 
special  attention.  When  one  plant  in  a  great  combination 
shows  a  lower  cost  per  unit  of  output  than  do  the  others, 
the  fact  is  at  once  known  to  the  officers  of  the  combina- 
tion, who  naturally  seek  to  learn  the  causes  of  this  supe- 
rior efficiency,  in  order  to  introduce  improvements  in  the 
estabUshments  of  less  efficiency.  Thus  in  a  consolidated 
enterprise  there  is  a  resistless  tendency  to  force  every 
establishment  to  keep  pace  with  the  one  which  displays 
the  greatest  efficiency. 

11.  Consolidation  encourages  a  JiigJier  degree  of  speciali- 
zation in  production  than  does  the  system  of  competitive 
enterprise. 

An  independent  establishment,  in  order  to  retain  its 
customers,  is  often  compelled  to  cover  a  comparatively 
wide  range  of  production.  This  involves  keeping  on  hand 
a  large  amount  of  machinery  which  can  be  used  only  for 
a  small  part  of  the  time.  It  also  involves,  in  many  cases, 
the  production  of  goods  for  which  the  supplies  of  mate- 
rial upon  which  it  relies  are  not  especially  well  adapted. 
A  consohdated  corporation  can  send  orders  received  to 
those  plants  which  are  in  the  best  position  to  execute 
them  promptly  and  efficiently. 

12.  Consolidation  makes  possible  the  supplying  of  each 
customer  from  the  plant  nearest  to  him,  and  thus  reduces 
cost  of  shipment. 

Where  an  industry  is  competitively  organized,  there  is 
a  tendency  for  each  producer  to  invade  the  territory  nat 


146  INTRODUCTION   TO   ECONOMICS 

urally  belonging  to  his  competitors.  Castings  for  use  in 
Alabama  should  naturally  be  made  in  Alabama ;  castings 
for  use  in  the  Pittsburg  district  should  naturally  be  made 
there.  But  if  there  is  competition  between  makers  of 
castings  in  the  two  centers,  some  of  the  products  of  Pitts- 
burg will  be  sent  to  Alabama,  and  vice  versa.  This  is 
sheer  waste,  and  consolidation  puts  a  stop  to  it,  to  the 
advantage  of  the  producer  and  of  society  as  well. 

It  is  true  that  under  the  competitive  regime  informal 
agreements  among  producers  to  respect  one  another's  ter- 
ritory kept  this  form  of  waste  within  bounds.  But  there 
was  always  disputed  territory,  in  which  freights  were  use- 
lessly carried  back  and  forth.  Consolidation  has  elimi- 
nated cross  freights,  except  in  cases  where  real  differences 
in  quality  make  supplying  from  a  distant  mill  necessary, 
or  where  the  nearest  mill  is  temporarily  overwhelmed  with 
orders. 

13.  Consolidation  reduces  the  chances  of  loss  from  over, 
supply  or  undersupply  of  the  market. 

When  an  industry  is  carried  on  by  a  large  number  of 
competing  employers,  each  one  is  in  greater  or  less  un- 
certainty as  to  whether  he  can  market  his  products  at 
remunerative  prices.  The  causes  for  uncertainty  are  first, 
possible  changes  in  the  demand,  over  which  the  industry 
has  no  control,  and  second,  changes  in  the  combined  out- 
put of  the  competing  establishments.  When  a  consolida- 
tion is  formed,  the  second  of  these  causes  is  eliminated. 
The  producer  knows  exactly  how  gi-eat  a  volume  will  be 
placed  upon  the  market.  There  is  consequently  less 
chance  that  great  stocks  will  accumulate  at  a  time  when 
the  demand  is  slack.  When  the  volume  of  orders  in- 
creases, the  full  extent  of  the  increase  is  readily  calcu- 
lated, and  preparations  may  be  made  for  a  correspondingly 
greater  output,  if  an  industry  is  consolidated.  If  an  indus- 
try is  not  consolidated,  each  producer,  although  receiving 


BUSTNKSS    COMBINATIONS  147 

an  increased  volume  of  orders,  is  uncertain  whether  the 
expansion  of  the  business  is  general  or  not,  and  so  delays 
preparations  for  increase  of  output,  with  the  result  that  at 
the  height  of  business  expansion  he  must  turn  away  orders 
at  profitable  prices. 

Herein  lies  one  of  the  chief  advantages  of  the  form  of 
consohdation  which  we  have  described  as  industrial  inte- 
gration. When  the  steel  industry  was  competitively  organ- 
ized, there  was  at  one  time  overproduction  of  ore,  at  another 
time  overproduction  of  pig  iron,  at  still  another  time  over- 
production of  steel  billets,  even  when  there  was  no  over- 
production in  the  final  stages  of  the  industry.  Under 
present  circumstances  all  stages  in  the  industry  keep  pace 
with  one  another.  If  the  demand  for  finished  products 
appears  to  be  on  the  increase,  a  symmetrical  increase  is 
ordered  in  the  production  of  ore,  pig  iron,  crude  steel,  and 
finished  products. 

14.  Co7isolidation  reduces  the  expenses  mcidental  to  the 
marketing  of  products. 

The  marketing  of  products  is,  in  many  lines  of  industry, 
a  very  complicated  process,  requiring  great  expense  for 
advertising  and  for  the  services  of  trained  salesmen.  A 
manufacturer  must  often  make  special  concessions  in  prices 
or  in  conditions  of  payment  in  order  to  introduce  his  goods  ; 
under  competition  he  is  always  in  danger  of  losing  custom 
because  of  the  efforts  of  his  rivals  to  introduce  their  goods. 
Some  efforts  are  of  course  necessary  under  the  most 
favorable  conditions  to  attract  the  attention  of  purchasers. 
But  it  is  manifestly  a  more  difficult  problem  to  attract  the 
attention  of  purchasers  away  from  a  rival's  wares  than  to 
attract  their  attention  to  the  general  class  of  goods.  Con- 
solidation results  in  important  economies  in  this  respect. 
The  Distilling  Company  of  America  is  said  to  have  saved 
$1,000,000  a  year  through  reduction  in  the  number  of  trav- 
eling salesmen,  made  possible  by  combination.     In  many 


148  INTRODUCTION   TO   ECONOMICS 

cases  consolidated  companies  have  been  able  to  dispense 
with  the  traveling  salesman,  since  purchasers,  having  no 
choice,  are  compelled  to  resort  directly  to  the  producer. 

One  of  the  more  important  sources  of  loss  to  the  com- 
petitive producer  was  the  failure  of  purchasers  to  pay  for 
goods  secured  on  credit.  The  producer  could  not  refuse 
credit,  since  by  doing  so  he  was  likely  to  lose  customers. 
The  consolidated  company  can  safely  insist  upon  cash  pay- 
ment, since  it  has  few  competitors  to  take  its  customers 
away  from  it. 

15.  The  consolidation  can  nsually  borroiv  mojiey  on  more 
favorable  terms  than  any  one  of  a  number  of  competing 
producers. 

As  a  result  of  the  manifold  advantages  of  the  consoli- 
dated company,  the  chances  of  its  failure  are  reduced  to  a 
minimum.  If  it  is  conservatively  managed,  loans  made 
to  it  possess  a  high  degree  of  security,  and  consequently 
bear  a  low  rate  of  interest.  Moreover,  the  mere  fact  that 
the  consolidation  represents  a  vast  aggregate  of  capital 
places  it  in  an  extremely  favorable  position  in  the  loan 
market.  Every  one  has  heard  of  the  Standard  Oil  Com- 
pany, the  United  States  Steel  Corporation,  the  Harvester 
Trust,  the  great  packing  companies.  Every  one  has 
formed  an  estimate  of  the  financial  standing  of  these  com- 
panies. Consequently  the  man  who  has  loaned  capital  to 
one  of  these  companies  can  easily  sell  his  claim  upon  it 
whenever  he  desires  to  regain  possession  of  his  funds.  A 
small  refinery  or  slaughtering  establishment  may  hold  a 
position  that  is  financially  as  sound  as  that  of  one  of  the 
great  companies  mentioned.  But  this  fact  is  not  generally 
known,  and  those  who  loan  money  to  the  lesser  companies 
find  far  greater  difficulty  in  disposing  of  their  claims  when 
they  desire  to  do  so.  For  this  reason  they  demand  a  higher 
rate  of  interest  than  they  would  be  willing  to  accept  from 
the  great  consolidation. 


BUSINESS   COMBINATIONS  149 

16.  TJic  most  important  advaiitagc  arising  from  consoli- 
dation is  the  control  over  prices  that  it  makes  possible. 

All  the  advantages  that  have  been  enumerated  would 
probably  have  been  insufficient  to  cause  an  extensive 
movement  in  the  direction  of  consolidation.  Most  of  them 
could  have  been  secured  through  a  form  of  combination 
that  would  leave  the  independence  of  the  individual  estab- 
lishment practically  unimpaired.  Combinations  of  inde- 
pendent establishments  for  purposes  of  price  control  are, 
under  the  American  system,  opposed  to  the  spirit  of  the 
law,  and  for  this  reason  could  not  be  satisfactorily  main- 
tained. In  Germany,  where  such  combinations  are  recog- 
nized by  law,  there  has  been  no  tendency  toward  complete 
consoUdation  such  as  we  have  in  America. 

It  is  still  a  disputed  question  whether  consolidation 
has  resulted  generally  in  a  material  advance  in  prices. 
There  are  a  number  of  cases  in  which  it  can  readily  be 
shown  that  these  vast  combinations  have  taken  advantage 
of  their  monopolistic  position  to  maintain  prices  at  a  level 
considerably  above  the  competitive  level.  In  other  cases, 
consolidation  appears  rather  to  steady  prices,  preventing 
very  low  and  very  high  prices,  than  to  raise  the  average 
level.  In  any  case,  the  rise  in  prices  due  to  consolidations 
has  been  far  less  than  a  consideration  of  the  monopoly 
position  of  these  aggregations  of  capital  would  lead  one  to 
expect.  The  checks  upon  monopoly  power,  described  in 
Chapter  IV,  appear  therefore  to  be  very  effective. 

17.  Summary. 

There  is  at  present  a  tendency  toward  the  formation  of 
combinations  of  business  establishments.  The  term  com- 
bination is  properly  applied  to  unions  between  establish- 
ments in  the  same  stage  in  the  production  of  a  commodity 
or  service;  it  is,  however,  also  applied  to  unions  of  estab- 
lishments in  successive  stages  in  the  production  of  a  com- 
modity.    The  latter  form  of  combination  is  also  termed 


150  INTRODUCTION   TO   ECONOMICS 

industrial  integration.  Combinations  may  be  temporary  or 
permanent,  partial  or  complete.  The  permanent  and  com- 
plete combination  is  known  as  a  consolidation. 

The  chief  forms  of  combination  have  been  the  pool,  the 
trust  and  the  holding  company.  The  pool  and  the  trust 
have  been  outlawed ;  existing  combinations,  commonly 
called  "  trusts,"  are  of  the  holding  company  type.  The 
holding  company  is  a  corporation  which  holds  the  stock  of 
companies  that  are  consolidated,  and  so  controls  their 
policy. 

The  advantages  of  consolidation  are  (i)  the  increased 
technical  efficiency  of  each  establishment,  through  appli- 
cation   of    methods    developed    in    other   establishments; 

(2)  greater  opportunity  for  the  specialization  of  each  estab- 
lishment to  particular  grades  of  the  commodity  produced ; 

(3)  reduction  in  transportation  charges;  (4)  avoidance  of 
oversupply  and  undersupply ;  (5)  reduction  in  cost  of 
marketing ;  (6)  reduction  in  interest  charges ;  (7)  control 
of  prices. 


CHAPTER   X 

COMPETITIVE   WAGES 

1.  T.abor  is  the  application  of  Jiiiman  faculties  to  the  prO' 
duction  of  zvealth. 

We  have  found  frequent  occasion  in  earlier  chapters  to 
touch  upon  wages  and  interest.  Wages  and  interest  are 
parts  of  the  cost  of  production  of  commodities,  as  we  saw 
in  Chapter  V,  and  as  such  have  an  important  part  to  play 
in  determining  values.  In  the  present  and  the  following 
chapters  we  shall  endeavor  to  ascertain  the  laws  deter- 
mining the  rates  of  wages,  interest,  and  whatever  other 
forms  of  social  income  may  remain  after  the  shares  of  the 
laborer  and  of  the  capitalist  are  paid.  In  other  words,  we 
are  entering  upon  a  study  of  the  distribution  of  wealth, 
or,  more  properly,  of  the  distribution  of  the  social  income. 

Every  expenditure  of  human  energy  having  for  its  chief 
purpose  the  production  or  the  preservation  of  economic 
goods,  or  the  increase  in  the  valuable  qualities  of  existing 
goods,  is  labor,  in  the  economic  sense  of  the  term.  Labor 
includes  not  only  the  exertions  of  the  manual  workers,  by 
whom  actual  changes  in  material  commodities  are  wrought, 
but  also  the  exertions  of  the  foremen,  superintendents, 
managers,  under  whose  direction  the  manual  tasks  are 
performed.  It  includes  the  activities  of  police,  of  judge, 
and  of  legislature,  upon  whose  efficient  performance  rest- 
the  possibility  of  continued  production  in  most  of  the  exist- 
ing branches  of  industry.  Labor  does  not  include,  how- 
ever, efforts  undertaken  for  their  own  sake,  without  regard 
to  economic  result.  The  amateur  football  team  spends  an 
immense  amount  of  energy,  and  gets  its  reward  in  the 


152  INTRODUCTION   TO   ECONOMICS 

spending.  The  amateur  hunter  often  cares  httle  or  noth- 
ing for  the  birds  he  brings  down;  his  reward  is  the  gratifi- 
cation of  the  preliistoric  thirst  for  blood.  The  professional 
football  player  and  the  professional  hunter,  on  the  other 
hand,  are  laborers.  If  any  one  thinks  that  this  is  a  dis- 
tinction without  a  difference,  let  him  ask  the  football 
amateur  what  claim  to  superiority  he  enjoys  over  the 
"professional";  let  him  ask  the  sportsman  wherein  the 
latter  differs  from  the  pot-hunter. 

2.  Wages  are  the  income  received  on  account  of  labor  per- 
formed. 

As  the  term  "  wages"  is  generally  used,  it  signifies  the 
money  or  other  things  of  value  paid  by  an  employer  to  those 
who  serve  him  in  capacities  of  inferior  dignity ;  employees 
of  higher  rank  receive  "salaries."  Political  economy  does 
not  recognize  any  such  distinction  as  this,  based  as  it  is  upon 
the  pretended  social  status  of  the  recipient,  rather  than  upon 
a  difference  of  economic  function.  The  ten  cents  a  day  paid 
to  a  child  slave  and  the  $100,000  a  year  jaaid  to  the  presi- 
dent of  an  insurance  company  are  alike  wages  in  the  blunt 
speech  of  the  economist.  Moreover,  in  economic  language, 
the  term  "wages"  extends  to  part  of  the  income  of  a 
workman  who  is  his  own  employer.  One  peanut  vender 
may  be  working  for  a  push-cart  enterpriser,  receiving  a 
dollar  a  day  for  his  efforts.  This  sum,  all  will  agree,  is 
nothing  but  wages.  At  the  opposite  corner  of  the  square 
you  may  find  another  peanut  vender,  who  is  his  own  em- 
ployer. The  latter  may  gain,  over  and  above  the  cost  of 
raw  nuts,  gasolene,  push-cart  hire,  etc.,  just  a  dollar  a  day. 
The  two  men  then  receive  equal  rewards  for  identical 
services.  Possibly  the  second  vender  calls  his  income 
"  profits."  Political  economy  cannot  afford  to  use  two 
different  terms  to  designate  essentially  the  same  thing, 
especially  when  one  of  the  terms,  "  profits,"  has  a  very 
definite  meaning  of  its  own.     Whatever  a  man   receives 


COMPETITIVE  WAGES  153 

simply  as  a  reward  for  his  exertions,  whether  directly  or 
through  the  intermediation  of  an  employer,  is  wages. 

3.  Cojiti'act  wages  involve  viore  importa)it  economic pj^ob- 
lems  than  docs  tJie  wage  income  of  the  independent  work- 
man. 

While  we  cannot  properly  exclude  from  the  term  wages 
so  much  of  the  income  of  an  independent  workman  as 
arises  from  his  personal  exertion,  we  are  nevertheless 
justified  in  devoting  our  attention  almost  exclusively  to 
wages  as  determined  by  contract  between  employer  and 
employee.  An  increasing  proportion  of  the  world's  work 
is  being  done  under  this  system,  and  most  of  the  impor- 
tant economic  problems  of  the  day  are  concerned  with  it. 
Who  ever  heard  of  a  "labor  problem"  in  an  agricultural 
community  where  every  farmer  relies  exclusively  on  his 
own  two  hands  t  In  such  a  community,  what  importance 
attaches  to  the  general  movement  of  wages,  whether  up- 
ward or  downward.''  Indeed,  who  can  determine,  in  such 
a  society,  how  much  of  the  total  income  of  each  farmer  is 
wages,  how  much  interest  on  capital  invested  in  the  farm  .'' 
Wages  have  existed  ever  since  our  first  ancestors  were 
condemned  to  eat  their  bread  in  the  sweat  of  their  brows; 
but  it  is  only  under  modern  conditions,  where  one  man 
pays  another  to  work  for  him,  that  it  comes  to  be  of  great 
importance  to  ascertain  what  laws  govern  the  rate  of 
wages.  We  shall  therefore  confine  our  study  to  that  part 
of  the  economic  field  in  which  differentiation  between 
employer  and  employee  has  taken  place — where  the 
"wage  system"  exists  —  and  shall  endeavor  to  ascertain 
the  laws  operative  therein.  These  laws,  indeed,  exert  an 
influence  in  the  rest  of  the  economic  field  as  well,  and  are 
in  turn  influenced  by  forces  lying  outside  of  the  field  in 
which  the  wage  system  prevails.  What  a  man  could  get 
as  his  own  employer  helps  to  determine  how  much  he 
must  have  as  a  mere  wage-earner;  what  he  could  get  as  a 


154  INTRODUCTION   TO   ECONOMICS 

mere  wage-earner  helps  to  determine  what  he  must  gain 
as  an  independent  workman. 

4.  The  returns  resultmg  frojn  the  employment  of  a  given 
amount  of  labor  vary  according  to  the  conditions  under  which 
labor  is  employed. 

Let  us  set  before  ourselves,  in  imagination,  an  agricul- 
tural community  in  which  all  the  land  is  owned  by  a  small 
class  of  men  who  do  not  themselves  engage  in  tillage,  but 
hire  the  landless  population  to  work  upon  their  fields.  And 
let  us  further  assume  that  this  population  is  unable  or  un- 
willing to  migrate  to  other  communities  in  search  of  em- 
ployment. Whether  there  are  many  workmen  or  few,  they 
must  all  seek  employment  upon  the  land,  or  starve. 

Some  of  the  land  in  the  community  is  fertile,  some  of  it 
barren.  Some  of  it  requires  a  large  expenditure  of  labor 
for  every  bushel  of  wheat  or  potatoes  produced  ;  some  of 
it  yields  rich  crops  with  little  labor.  Every  good  ileld 
yields  a  moderate  crop  with  a  small  expenditure  of  labor ; 
if  a  larger  crop  is  sought,  it  must  be  at  the  expense  of  a 
disproportionately  large  application  of  labor,  as  we  saw  in 
the  chapter  on  Diminishing  Returns. 

Accordingly,  we  may  safely  lay  down  the  proposition 
that  the  results  arising  from  the  application  of  labor  to  dif- 
ferent fields,  and  in  different  methods  of  cultivation,  will 
be  unequal.  Good  land,  in  extensive  cultivation,  may  yield 
three  bushels  of  wheat  per  day's  labor  expended,  while 
poorer  land  yields,  perhaps,  two  bushels,  and  yet  poorer 
land  one  bushel.  Adding  one  day's  labor  to  the  amount 
previously  spent  on  a  piece  of  the  best  land  may  add  only 
two  bushels  to  the  product,  and  adding  still  another  day's 
labor  may  add  only  one  bushel. 

5.  Equal  wages  for  equal  tasks  is  the  rule  of  competitive 
industry. 

However  unequal  the  results  of  labor  on  different  fields 
and  under  different  methods  of  cultivation,  the  reward  of 


COMPETITIVE   WAGES  155 

labor  —  wages  —  will  tend  to  be  uniform,  allowance  made, 
of  course,  for  differences  in  the  physical  efficiency  of  dif- 
ferent laborers.  Suppose  that  a  farmer  has  ten  fields,  of 
different  degrees  of  fertility,  and  employs  one  man  to  cul- 
tivate each,  the  work  on  the  different  fields  being  uni- 
formly arduous.  He  would  be  a  very  unusual  employer 
if  he  should  propose  to  pay  the  men  different  rates  of 
wages,  according  to  the  fertility  of  the  field  upon  which 
each  is  employed.  The  probable  result  of  such  a  plan 
would  be  that  competition  would  arise  among  the  men  to 
win  the  employer's  favor,  each  one  desiring  to  be  employed 
on  the  best  field;  and  in  the  end  we  should  probably  find 
that  the  better  fields  would  be  apportioned  to  the  men  who 
would  agree  to  perform  for  the  employer  various  miscel- 
laneous services  which  would,  generally  speaking,  be  equal 
in  value  to  the  advantages  they  enjoyed  in  the  way  of 
higher  remuneration.  How  this  would  work  out  we  might 
consider  at  greater  length  if  we  did  not  know  by  experi- 
ence that  even  the  most  liberal  employer  is  averse  to  grad- 
ing the  wages  of  his  men,  not  on  a  basis  of  their  skill  and 
faithfulness,  but  on  a  basis  of  the  facilities  for  work  which 
the  employer  himself  furnishes.  Cases  of  unequal  rewards 
for  the  performance  of  equal  tasks  are  of  course  to  be 
found ;  but  for  these  cases  the  explanation,  as  we  shall  see 
later,  is  of  a  wholly  different  nature. 

Just  as  uniform  wages  will  be  paid  for  like  tasks  by  any 
one  employer,  so  uniform  wages  will  be  paid  by  all  the  em- 
ployers in  the  community.  No  employer  can  keep  in  busi- 
ness unless  he  pays  as  good  wages  as  any  other.  If  any 
one  raises  wages  slightly,  he  will  attract  to  himself  an  in- 
creasing number  of  workmen,  and  he  will  soon  get  all  he 
cares  to  have.  In  an  earlier  chapter  we  saw  that  there 
cannot  be  different  prices  for  the  same  commodity  in  the 
same  market.  This  law  holds  good  for  labor  as  for  any- 
thing else  one  buys  or  sells. 


156  INTRODUCTION   TO   ECONOMICS 

6.  TJie  wages  of  any  one  of  a  rnimber  of  laborers  of  equal 
efficiency  zvill  not  exceed  the  addition  to  product  made  by  tht 
laborer  zvhose  sennces  are  least  important  to  the  employer. 

Of  ten  fields,  the  best  one,  when  cultivated  by  one  work- 
man, may  yield  a  product  worth  $500;  the  worst  one  may 
yield  only  $  1 50.  What  will  be  the  maximum  wage  that  the 
employer  will  pay  ?  Not  more  than  $150,  For  he  will  not 
pay  any  workman  more  than  the  entire  product  created  by 
the  aid  of  that  workman,  and  he  will  not,  of  his  own  volition, 
pay  one  workman  more  than  another.  Nor  can  any  work- 
man compel  the  employer  to  pay  him  more  than  the  one  on 
the  worst  field  receives.  Suppose  that  the  one  employed 
on  the  best  field  insisted  on  a  wage  of  ^200.  The  employer 
would  dismiss  him,  and  place  on  that  field  the  laborer 
formerly  employed  on  the  worst  field.  And  so  with  any 
one  of  the  ten  laborers.  What  the  employer  would  lose,  if 
any  one  of  them  should  "  strike,"  would  be  simply  the 
product  of  the  worst  field  —  ^i  50,  according  to  our  premises. 

If  we  assume  that  the  ten  fields  are  owned  by  different 
men,  we  arrive  at  an  identical  result.  The  employer  who 
owns  the  poorest  field  cannot  possibly  pay  more  than  ^150 
to  the  workman  who  tills  it.  If  a  workman  on  a  better  field 
demands  more,  his  employer  will  dismiss  him,  and  put  in  his 
place  the  workman  formerly  employed  on  the  poorest  field, 
whom  he  can  easily  induce  to  change  employers  by  offering 
him  a  trifle  more  than  the  owner  of  the  poorest  field  is  able 
to  pay.  The  dismissed  workman  must  live ;  probably  he 
will  have  to  seek  employment  on  the  abandoned  field,  and 
content  himself  with  the  wages  that  the  owner  of  that  field 
can  pay. 

If  we  assume,  instead  of  ten  fields  of  varying  fertility, 
one  large,  fertile  field,  giving  employment  to  ten  men,  we 
see  exactly  the  same  principle  at  work.  One  of  the  men, 
cultivating  the  land  extensively,  may  produce  $500;  a 
second  may  add  to  this  product  $450;  a  tenth  may  add  to 


COMPETITIVE  WAGES  157 

the  total  product  of  the  nine  previously  employed  only 
$150.  The  employer  will  not  pay  the  first  $500,  the  sec- 
ond $450,  and  so  on  down  to  $150.  He  will  pay  each  one 
not  more  than  $150.  If  any  one  should  demand  more,  he 
would  be  dismissed,  and  his  functions  performed  equally 
well  by  the  man  who  otherwise  would  have  added  only 
$150.  What  the  employer  loses,  when  he  loses  any  man 
of  the  ten,  is  the  product  created  by  the  least  important 
one  of  them  all. 

7.  TJie  wages  of  any  one  of  a  nuuiber  of  laborers  of  equal 
efficiency  camiot,  under  competition,  be  permanently  less  than 
the  marginal  product  of  labor,  or  the  addition  to  product 
made  by  the  laborer  zvhose  services  are  of  least  importance 
to  his  employer. 

We  have,  then,  an  upper  limit  of  wages  above  which  an 
employer  cannot  be  compelled  to  go :  the  addition  to  the 
total  output  created  by  the  man  who  works  at  the  greatest 
disadvantage.  Is -there,  similarly,  a  lower  limit.-'  In  the 
situation  we  have  assumed — -a  number  of  competing  em- 
ployers, each  able  to  increase  his  employment  of  men 
through  breaking  up  new,  though  less  fertile,  lands,  or 
through  more  intensive  tillage  of  lands  already  under  cul- 
tivation —  it  is  unlikely  that  any  employer  will  make  a  large 
net  return  on  the  last  man  he  employs.  Let  us  assume  that 
the  uniform  yearly  rate  of  wages  is  ^120,  while  the  product 
of  the  least  important  man  varies  from  $120  on  the  least 
fertile  farms  to  $175  on  the  most  fertile  ones.  The  man 
who  has  a  fertile  farm  can  increase  his  net  income  by  offer- 
ing a  little  more  than  $120  for  an  additional  workman.' 
Such  a  workman  will  not  add  $175  to  the  total  output  — 
the  law  of  diminishing  returns  forbids  this  —  but  he  may 
add  $170.  As  the  employer  on  the  least  fertile  field  secures 
a  product  of  only  $120  from  his  last  man,  he  is  compelled 
to  let  a  man  go.  Perhaps  the  man  who  now  becomes 
his  least  important  hand  is  worth  $12$  to  him,  and  $125 


158  INTRODUCTION   TO   ECONOMICS 

may  be  what  the  man  on  the  next  better  field  is  worth.  It 
still  pays  the  farmer  with  the  best  fields  to  seek  additional 
hands.  The  wage  he  must  now  offer  is  more  than  ^125,  — 
let  us  say,  ^130.  And  the  additional  men  will  be  worth 
less  to  him  —  perhaps  $165  each.  Competition  will  still  go 
on  between  the  employers  having  the  better  fields  and 
those  having  fields  that  are  not  so  good,  each  rise  in  wages 
affecting,  of  course,  the  wages  of  all  the  workmen  in  the 
community.  At  last  a  point  is  reached  where  no  employer 
can  take  a  workman  away  from  his  competitor  without 
offering  a  wage  so  high  as  to  outweigh  the  advantages 
.to  be  derived  from  an  additional  employee.  Here,  then, 
wages  will  tend  to  remain  stationary.  Each  employer  will 
be  paying  his  least  im[)ortant  man  so  much  that  any  in- 
crease in  wages  would  make  that  man  an  unprofitable 
member  of  his  working  force.  No  employer  would  care 
to  take  on  an  additional  man  at  the  existing  rate  of  wages. 
This  means  that  on  every  farm  the  least  important  work- 
man adds  to  the  total  product  only  enough  to  cover  his 
wages.  The  addition  to  product  made  by  the  man  working 
under  the  least  favorable  circumstances  is,  then,  not  only 
the  maximum  that  the  employer  can  be  compelled  to  pay  ; 
it  is  also  the  minimum  which  he  cannot  avoid  paying.  If 
we  describe  as  the  "  product  of  labor,"  that  amount  of 
valuable  product  which  is  brought  into  being  by  the  pres- 
ence of  any  particular  laborer,  we  may  say  that,  under  com- 
petition, wages  are  determined  by  the  product  of  the  laborer 
working  under  the  least  advantageous  circumstances  (in  this 
case,  on  the  poorest  land).  This  laborer  is  known  in  eco- 
nomics as  the  marginal  laborer,  as  he  is  on  the  "  margin  " 
or  fringe  of  employment,  as  it  were  —  in  a  position  where 
his  continued  employment  is  almost  a  matter  of  indifference 
to  the  employer,  since  his  presence  means  neither  profit 
nor  loss.  In  the  customary  economic  formula,  zvages,  iiJi 
der  competitive  conditions,  are  determined  by  tJie  marginal 


COMPETITIVE   WAGES  159 

productivity  of  labor  (i.e.  the  productivity  of  the  marginal 
workuian). 

8.  A)i  increase  in  the  personal  efficiency  of  labor  tends  tc 
raise  wao-es. 

Let  us  suppose  that  in  the  course  of  time  the  working 
force  of  our  assumed  community  becomes  more  efficient, 
either  through  increased  intelligence  or  through  improve- 
ment in  skill  or  in  physical  strength.  This  might  well  be 
the  case  if  the  community  is  a  comparatively  new  one,  with 
a  population  imperfectly  adjusted  to  its  environment.  It 
would  then  be  quite  possible  that  the  product  of  the  men 
working  under  the  least  favorable  conditions  would  in- 
crease, let  us  say,  by  ten  per  cent.  Wages  under  competi- 
tion would  also  increase  by  ten  per  cent. 

Many  causes  besides  changes  in  the  personal  efficiency 
of  labor  are  operative  in  raising  or  lowering  the  level  of 
wages.  But  it  cannot  be  doubted  that  the  extremely  low 
wages  paid  in  such  countries  as  India  are  in  large  measure 
due  to  the  low  average  efficiency  of  the  laboring  class. 
The  high  wages  paid  in  America  are  in  part  accounted 
for  by  the  fact  that  American  conditions  spur  the  work- 
man to  an  activity  surpassing  that  of  workmen  in  other 
countries.  It  has  often  been  noted  that  immigrants  from 
European  countries  work  much  harder  than  they  did  in 
their  native  lands. 

9.  Ah  increase  in  the  number  of  workers  tends  to  reduce 
viargi}ial  productivity  and  zvages. 

Now  let  us  assume  that  the  number  of  workmen  in  the 
community  is  increased  by  the  immigration  of  equally  ef- 
ficient workmen  from  another  part  of  the  country.  The 
new  men  must  have  employment ;  and  there  is  of  course 
plenty  of  work  in  the  community  for  them  to  do  —  on  one 
condition,  however.  They  must  accept  employment  on 
fields  yet  poorer  than  any  now  cultivated,  or  they  must 
be  added  to  the  force  at  work  upon  the  better  land,  occu- 


i6o  INTRODUCTION   TO   ECONOMICS 

pying  themselves  with  tasks  that  formerly  were  neglected. 
In  either  case  they  will  add  less  to  the  product  than  was 
created  by  the  marginal  workman  before  the  arrival  of  the 
new  hands.  They  must  accept  a  rate  of  pay  lower  than 
that  which  formerly  prevailed,  else  no  employer  could 
afford  to  hire  them.  And  as  there  will  not  be  two  rates  of 
wages  for  equally  efficient  men,  the  general  rate  for  all 
the  workmen  originally  employed  in  the  community  must 
be  reduced.  If  the  immigration  continues  steadily,  other 
things  remaining  the  same,  the  marginal  product  of  labor, 
and  with  it  the  rate  of  wages,  must  steadily  sink. 

If,  on  the  other  hand,  some  of  the  original  landless  popu- 
lation should  move  away,  some  of  the  worst  fields  would 
be  abandoned,  and  it  would  become  impossible  to  cultivate 
the  better  fields  as  intensively  as  before.  On  each  field 
the  importance  of  the  marginal  man  would  increase. 
If  any  employer  should  persist  in  paying  the  old  rate 
of  wages,  his  competitors,  by  offering  a  little  more,  would 
entice  his  men  away.  The  tendency  for  wages  to  rise, 
with  decline  in  the  laboring  population,  would  be  as  irre- 
sistible as  the  tendency  for  wages  to  fall  with  an  increase 
in  population. 

10.  Improvements  in  methods  of  production  tend,  as  a  rule, 
to  raise  wages. 

Let  us  suppose  that  in  this  community  are  found  exten- 
sive tracts  of  marshy  land  of  practically  no  economic 
importance.  A  competent  engineer  enters  the  commu- 
nity, and  at  a  comparatively  low  expense  drains  these 
lands  and  transforms  them  into  the  very  best  quality 
of  tillable  soil.  The  owners  of  the  drained  lands  must 
have  labor,  and  can  bid  a  higher  price  than  prevails 
generally.  If  the  laboring  population  remains  stationary, 
the  effect  of  the  aew  demand  for  labor  is  to  withdraw  men 
from  the  least  favorable  situations  and  place  them  upon 
the  new  land.     On  every  farm  the  product  of  the  marginal 


COMPETITIVE   WAGES  i6i 

workman  is  increased,  and  wages  rise  accordingly.  If 
immigration  of  laborers  is  going  on,  the  new  demand  for 
labor  counteracts  the  effect  upon  wages  of  the  new  supply  ; 
if  emigration  is  taking  place,  the  rise  in  wages  that  would 
otherwise  occur  is  emphasized. 

A  similar  influence  may  be  exerted  by  a  general  im- 
provement in  agricultural  practice.  It  is  said  that  by  the 
use  of  seed  corn  which  has  been  grown  in  an  isolated  field 
from  which  all  barren  stalks  have  been  removed  before 
maturity,  the  average  yield  of  corn  may  be  increased  from 
ten  to  thirty  per  cent.  This  increased  yield  is  obtained 
without  additional  labor,  excepting  a  small  amount  entailed 
by  the  care  of  the  seed  corn  field.  The  use  of  such  seed 
corn  in  the  community  we  are  studying  would  increase  the 
product  of  every  laborer,  that  of  the  marginal  ones  as  well 
as  that  of  the  rest,  and  the  competition  of  employers  with 
one  another  would  force  them  to  raise  wages  in  the  meas- 
ure of  the  increased  marginal  productivity.  The  intro- 
duction of  a  new  forage  plant,  like  Kaffir  corn  or  alfalfa, 
might  have  a  similar  effect  in  increasing  the  productivity 
of  the  marginal  laborers.  So  also  might  the  use  of  a  new 
kind  of  fertilizer,  or  the  invention  of  a  new  agricultural 
implement.  Almost  all  agricultural  improvements,  in  fact, 
are  likely  to  have  the  effect  of  increasing  the  productivity 
of  labor  and  the  rate  of  wages. 

It  is  not  in  the  least  necessary  that  such  improvements 
find  general  application.  An  improvement  increasing  the 
productivity  of  labor  on  one  tenth  of  the  farms  will  gener- 
ally lead  to  an  increased  demand  for  labor  on  those  farms. 
The  demand  is  met  by  the  withdrawal  of  labor  from  the 
farms  not  affected  by  the  improvement ;  and  this  results 
in  raising  the  productivity  of  the  least  favorably  situated 
laborers  on  those  farms,  and  so  raises  general  wages. 

11.  A  reduction  in  the  rate  of  interest  tends  to  raist 
wages. 


i62  INTRODUCTION   TO   ECONOMICS 

One  other  influence  needs  to  be  noted  here ;  namely,  a 
fall  in  the  rate  of  interest.  There  are  few  farms  that  could 
not  be  made  to  yield  a  much  larger  product,  if  abundance 
of  auxiliary  capital  were  to  be  had  at  a  low  rate  of  interest. 
If  a  farmer  must  pay  ten  per  cent  on  borrowed  capital,  he 
cannot  build  a  good  barn  or  drain  a  marsh  until  he  has 
accumulated  a  considerable  amount  of  capital  of  his  own. 
In  the  meantime  opportunities  for  labor  which  would  be 
thrown  open  if  capital  were  to  be  had  at  five  per  cent  lie 
untouched,  and  the  existing  labor  supply  is  spread  over 
barren  fields,  with  consequent  low  productivity.  Every 
reduction  in  the  interest  rate  creates  a  new  demand  for 
labor,  and  withdraws  part  of  the  existing  supply  from  the 
poorer  fields,  thus  increasing  marginal  productivity  and 
wages. 

•12.  //,;  a  complex  industrial  society,  laborers  fall  ittto  many 
classes  between  which  there  is  no  direct  competition. 

We  may  now  sum  up  the  results  of  our  study  of  wages 
under  the  assumed  conditions.  Wages  are  determiited  by 
the  marginal  productivity  of  labor,  but  marginal  produc- 
tivity itself  is  subject  to  many  and  varied  influences,  such 
as  arise  from  increase  or  decrease  in  number  of  laborers ; 
increase  or  decrease  in  the  amount  of  available  land ;  the 
progress  of  improvements ;  the  fluctuations  in  the  interest 
rate.  Let  us  now  see  how  far  we  can  apply  the  same 
reasoning  to  the  determination  of  wages  under  conditions 
nearer  like  those  of  modern  industry,  confining  ourselves, 
however,  to  those  parts  of  the  industrial  field  in  which 
competition  exists  among  employers  on  the  one  hand  and 
among  workmen  on  the  other. 

The  first  fact  that  we  must  take  into  consideration  is 
that  we  cannot  assume  that  in  this  wide  field  of  industry 
every  workman  can  enter  into  direct  competition  with 
every  other  workman,  and  thus  bring  about  an  immediate 
equalization  of  wages.     The  journeyman  tailor  cannot  be 


coMPETrnvi-:  wages  163 

replaced  by  the  excavator  nor  by  the  farm  hand ;  the 
cotton-mill  operative  cannot  take  the  place  of  the  iron 
and  steel  worker.  At  any  given  time,  then,  there  may  be 
many  rates  of  wages,  not  one  universal  rate. 

As  we  enter  upon  a  study  of  the  forces  which  are 
responsible  for  the  differences  in  wages  in  the  various 
trades  and  occupations,  we  encounter  a  difficulty  which 
has  not  hitherto  arisen  to  vex  us.  How  can  we  say  what 
differences  in  general  rates  really  exist .?  In  all  our  dis- 
cussion up  to  this  point,  we  have  spoken  of  equal  rewards 
for  equal  services.  Of  course  if  one  bricklayer  does  twice 
as  much  work  as  another,  lie  is  likely  to  receive  twice  the 
wages.  But  if  a  tailor  receives  twice  the  wages  of  a  brick- 
layer, how  can  we  say  that  it  is  because  he  does  twice  as 
much  work.''  Clearly,  it  is  not  possible  to  reduce  tailor's 
labor  to  terms  of  bricklayer's  labor,  so  as  to  show  whether 
one  is  rewarded  more  liberally  than  the  other. 

13.  Through  the  apportionment  of  neiv  additio)is  to  the 
working  force,  ivagcs  in  different  oeciipations  requiring 
equal  natural  endoivments  tend  tozvard  an  equality. 

Let  us  suppose  that  there  are  half  a  dozen  occupations 
in  a  community,  all  of  which  require  of  beginners  about 
the  same  degree  of  intelligence,  dexterity,  and  strength, 
although  they  differ  as  widely  in  their  nature  as  bricklayer's 
and  tailor's  labor,  so  that  no  direct  comparison  of  wages  is 
possible.  Is  there  any  reason  why  differences  in  wages 
per  day  should  exist .-'  At  first,  we  should  expect,  the 
choice  of  occupations  would  be  more  or  less  a  matter  of 
chance.  A  boy  would  enter  one  of  the  trades  because  his 
father  followed  it;  another,  because  his  best  friend  in- 
tended to  enter  it,  and  so  on. 

Once  in  the  trade,  a  man  would  have  to  remain  there, 
unless  he  wished  once  more  to  go  through  the  tedious 
tasks  of  a  beginner.  The  different  trades  would  thus  be 
walled  off,  as  it  were,  one  from  the  other.     Mature  reflec- 


i64  INTRODUCTION   TO   ECONOMICS 

tion  might  convince  a  man  that  he  had  made  a  mistake  in 
choosing  his  trade  ;  but  this  would  not  mend  matters.  His 
earnings  would  be  wholly  subject  to  the  laws  of  his  trade. 
If  many  men  happened  to  be  in  the  trade,  and  the  demand 
for  their  services  were  limited,  some  of  them  would  have 
to  be  set  at  unimportant  tasks,  which  could  not  be  well  re- 
munerated. And  competition  among  the  men  would  force 
wages  down  to  the  level  of  remuneration  of  these.  If 
the  trade  were  but  scantily  supplied  with  men,  all  might  be 
employed  at  work  that  could  pay  a  high  reward,  and  so  a 
high  rate  of  wages  would  prevail.  In  each  trade  the  rule 
that  marginal  productivity  determines  wages  would  apply  ; 
but  marginal  productivity  would  be  unequal,  for  men  of 
equal  native  ability,  in  the  different  trades. 

In  every  trade,  however,  a  constant  supply  of  new  re- 
cruits is  necessary  to  keep  its  ranks  full,  and  the  pros- 
pective apprentice  has  at  any  rate  some  freedom  of  choice. 
In  one  trade,  he  finds  men  discontented  and  impoverished  ; 
in  another  trade,  he  finds  every  appearance  of  prosperity* 
Unless  he  is  very  blind,  he  will  choose  a  trade  in  which 
the  latter  condition  prevails.  So  the  tide  of  apprentices 
sets  steadily  away  from  the  underpaid  trades,  and  in  the  di- 
rection of  the  better  paid  ones.  Failing  numbers,  in  the 
former  trades,  raise  the  marginal  productivity  of  labor; 
increasing  numbers,  in  the  more  prosperous  trades,  re- 
duce wages  there.  Whether  this  process  will  continue 
until  perfect  equality  of  rewards  is  estabhshed  for  men  of 
equal  native  ability  in  different  trades,  we  cannot  say. 
The  equalization  depends  upon  the  good  judgment  of 
the  prospective  apprentices  in  their  choice  of  trades ; 
and  these,  like  all  men,  are  likely  to  err.  But  gross 
inequality,  under  the  circumstances,  could  hardly  long 
persist. 

14.    P ermanent  differences  in  competitive  wages  are  caused 
by  differences  in  the  marginal  productivity  of  labor,  original' 


COMPETITIVE   WAGES  i6 


D 


iiig  in  influences  affecting  the  distribution  of  the  supply  of 
labor. 

Some  of  the  differences  in  wages  actually  existing  ap- 
pear to  be  fortuitt)us,  as  those  assumed  in  the  foregoing  ex- 
ample. But  many  of  these  differences  are  clearly  connected 
with  the  personal  qualifications  of  the  workman  —  his 
strength  and  skill,  his  intelligence  and  rehability.  Others 
are  connected  with  the  different  degrees  of  risk,  agreeable- 
ness,  and  dignity  of  the  employment  itself.  Still  others  de- 
pend upon  trade  union  requirements,  or  legal  restrictions. 
What  we  are  concerned  with  here,  however,  is  not  to  classify 
the  causes  of  differences  in  the  wages  paid  in  different  oc- 
cupations, but  to  see  exactly  how  these  causes  operate. 

We  know,  for  example,  that  a  dangerous  occupation  is 
likely  to  carry  with  it  a  higher  remuneration  than  a  safe 
one  ;  that  an  occupation  requiring  a  long  apprenticeship  is 
ordinarily  better  paid  than  one  requiring  practically  no 
training.  Why  may  we  not  say,  then,  that  a  part  of  a 
man's  reward  is  for  labor,  part  of  it  for  risk  .''  If  a  tedious 
apprenticeship  is  necessary,  may  we  not  say  that  part  of 
the  reward  of  the  journeyman  is  a  compensation  for  the 
time  and  trouble  spent  in  learning  the  trade .''  Such  an 
explanation  would  be  quite  satisfactory  if  we  actually 
found  that,  other  things  equal,  wages  were  nicely  graded 
according  to  risk,  or  to  the  length  of  the  period  of  appren- 
ticeship—  if,  for  example,  we  found  that  a  workman  in  an 
occupation  involving  no  appreciable  risk  received  a  wage 
represented  by  x,  an  equally  efficient  workman  in  an 
occupation  involving  a  considerable  risk  received  x -\- y, 
and  a  third  workman,  in  an  occupation  twice  as  dangerous 
as  the  second,  received  x-f-  2j,  and  so  on.  But  we  do  not 
find  in  real  life  any  such  simple  rule  as  this.  Danger- 
ous occupations,  we  often  find,  are  very  ill  paid  iu  compari- 
son with  occupations  requiring  no  greater  natural  ability 
and  entailing  no  risk  worth  speaking  of.     Almost  the  least 


i66  INTRODUCTION   TO   ECONOMICS 

remunerative  occupation  that  an  able-bodied  citizen  of  the 
United  States  can  engage  in  is  that  of  soldier,  and  this 
in  spite  of  the  fact  that  the  Federal  government  prides 
itself  upon  being  a  liberal  employer.  Certainly  the  risks 
of  the  occupation  are  considerable.  A  man  who  accepts 
employment  as  trainman  on  the  American  railways  stands 
one  chance  out  of  one  hundred  and  twenty  of  meeting  a 
violent  death  within  a  year,  and  one  chance  out  of  nine  of 
being  injured.  His  average  daily  compensation  will  vary 
from  $2.09,  if  he  is  a  fireman,  to  $4.25,  if  he  is  an  engi- 
neer. In  either  case,  he  is  a  man  of  more  than  average 
physical  strength  and  general  intelligence.  If  he  is  an 
engineer,  he  is  also  a  man  who  has  at  least  as  much  train- 
ing as  the  average  skilled  laborer.  What  we  really  find  is 
that  in  some  cases  no  allowance  appears  to  be  made  for 
risk ;  in  more  cases  some  allowance  is  made  for  it,  but 
there  is  no  apparent  tendency  for  this  allowance  to  vary 
regularly  with  the  degree  of  risk.  Similarly  with  dif- 
ferent degrees  of  skill.  Ordinarily,  the  skilled  laborer, 
who  has  undergone  a  long  apprenticeship,  receives  a  higher 
reward  than  the  unskilled  laborer  of  equal  native  intelli- 
gence. In  some  cases,  however,  this  does  not  appear  to 
hold  true  ;  and  it  is  idle  to  attempt  to  show  that  there  is  any 
ascertainable  proportion  between  degrees  of  skill  and  dif- 
ferences of  remuneration.  So  also  with  disagreeableness  of 
work.  Little,  if  any,  allowance  is  ordinarily  made  for  it  in 
wages,  although  in  some  cases  it  seems  to  play  a  very  im- 
portant part.  Clearly,  then,  it  is  not  enough  to  say  that 
wages  are  affected  by  risk,  by  skill  required,  by  disagreeable- 
ness of  occupation.  We  must  know  how  these  causes 
operate,  and  why  they  operate  with  such  irregularity. 

Let  us  see  if  a  concrete  example  will  not  make  clear 
the  relation  risk  actually  bears  to  wages.  Imagine  that  a 
gunpowder  factory  is  erected  at  a  distance  of  a  few  miles 
from  a  city  of    some  size,   and   let  us  suppose    that   five 


COMPETITIVE   WACxES  167 

hundred  workmen  will  be  required,  and  that  they  will  be  of 
a  grade  of  skill  that  would  command  an  average  of  ^3  a 
day  in  perfectly  safe  occupations.  How  much  will  it  be 
necessary  to  add  to  this  sum,  to  induce  them  to  enter  the 
powder  works  ? 

Now,  the  first  question  that  is  likely  to  arise  is,  How 
much  danger  is  there  that  the  works  will  blow  up  ?  You 
do  not  know  this,  neither  do  I ;  nor,  we  may  venture  to 
say,  do  the  workmen  whom  it  is  sought  to  employ.  Per- 
haps there  is  no  danger  at  all  in  the  present  stage  of  the 
powder  manufacture.  Powder  mills  have  often  blown  up, 
however,  and  most  of  us  would  prefer  to  stay  out  of  them. 

In  every  community  there  are  some  men  who  do  not 
seem  to  be  in  the  least  afraid  of  danger.  They  may  know 
that  destruction  has  befallen  others,  but,  each  argues, 
everybody  can't  be  killed ;  why  should  I  be .''  Such  men 
have  supreme  confidence  in  their  luck.  Danger,  real  or 
imputed,  does  not  influence  their  conduct.  Now,  if  there 
are  a  thousand  men  of  this  kind  in  the  city,  it  will  be  quite 
possible  to  man  the  powder  mill  without  offering  any  more 
of  an  advance  in  wages  than  would  have  to  be  offered  by 
an  enterpriser  who  proposed  to  establish  a  new  shoe  fac- 
tory or  nail  mill.  The  powder  manufacturer,  as  any  one 
else  starting  a  new  enterprise,  will  offer  wages  a  little 
higher  than  those  prevailing  in  the  city  —  ten  cents  more 
per  day,  perhaps.  Not  every  one  will  jump  at  the 
chance  to  improve  his  wages ;  but  the  men  who  despise 
danger  will  one  by  one  leave  their  former  employments 
and  enter  the  doors  of  the  powder  mill.  Presently  wages 
will  be  reduced  to  the  general  level.  No  man  will  for  this 
reason  leave  the  mill,  nor  need  the  enterpriser  care  if  a 
few  should  do  so,  for  there  are  still  plenty  of  men  in  the 
city  who  are  not  disturbed  by  fear  of  accident. 

But  suppose  that  instead  of  one  thousand  such  men, 
there  are  only  one  hundred.     The  powder  manufacturer 


1 68  INTRODUCTION   TO   ECONOMICS 

will  find  that  ten  cents  extra  a  day  fails  to  bring  the  fuU 
complement  of  men.  Perhaps  he  will  offer  twenty-five 
cents  extra ;  and  this  may  bring  another  hundred  men, 
who  fear  for  their  lives,  indeed,  but  desire  the  additional 
income  extremely.  An  additional  twenty-five  cents  may 
bring  another  hundred,  more  timid  or  less  eager  for  high 
wages.  At  the  rate  of  $i  a  day  above  the  prevailing  rate, 
the  enterpriser  may  be  able  fully  to  man  his  works. 

Now,  we  may  ask  ourselves,  is  this  extra  dollar  a  com- 
pensation for  risk .''  Remember,  there  may  be  no  real  risk 
at  all,  and  it  may  be  that  it  is  nothing  but  the  name  of 
powder  that  has  kept  the  workmen  back  and  forced  up 
wages.  And  how  is  it  that  a  powder  manufacturer  is  able 
to  pay  men  for  risk,  at  their  own  estimate  —  very  likely  a 
mistaken  one,  too  ?  Well,  the  powder  manufacturer  is  ex- 
periencing the  ordinary  incidents  of  his  business.  Every- 
where powder  manufacturers  have  to  contend  with  the 
same  indisposition  on  the  part  of  the  ordinary  workman 
to  enter  their  mills.  Everywhere  the  amount  of  available 
labor  is  limited,  relatively  to  the  demand  for  it.  And  so 
the  productivity  of  a  laborer,  measured  in  value  of  powder 
produced,  is  high,  and  wages  may  be  high  accordingly. 
If,  however,  the  number  of  men  who  do  not  mind  the 
danger  were  sufficient  fully  to  man  all  the  powder  works, 
more  powder  would  be  produced,  its  value  would  be  less, 
and  the  productivity  of  labor,  in  value,  would  fall  until  it 
corresponded  with  that  of  labor  in  other  occupations  re- 
quiring equal  skill. 

If  the  risks  to  life  and  limb  undergone  by  locomotive 
firemen  and  engineers  were  reduced  by  fifty  per  cent, 
through  the  introduction  of  better  safety  appliances,  the 
improvement  of  track,  etc.,  how  much  could  wages  be  re- 
duced .-'  I  have  never  heard  of  a  railway  president  who 
proposed  to  spend  the  company's  money  in  reducing  the 
chances  of  accident  with  the  expectation  that  part  of  the 


•      COMPETITIVE   WAGES  169 

cost  might  be  met  by  a  reduction  in  wages.  Nor  do  we 
find  that  wages  are  particularly  high  in  the  sections  of  the 
country  where  transportation  is  conducted  at  the  greatest 
cost  in  life  and  limb.  Here,  it  appears,  is  a  case  in  which 
a  great  industry  is  able  to  rely  upon  the  existing  supply  of 
men  who  bear  risks  cheerfully,  without  any  extra  compen- 
sation. The  marginal  laborer,  in  transportation,  is  no  more 
productive  than  the  marginal  laborer  in  general  industry  ; 
therefore  he  is  no  better  paid. 

15.  TJie  stiuidards  of  living  of  tJie  working  class,  tJwongJi 
limiting  the  sitpply  of  labor,  may  affect  marginal  produc- 
tivity, and,  tJiereforc,  may  affect  wages. 

Finally,  we  may  consider  the  effect  of  the  so-called 
"  standard  of  living  "  upon  productivity  and  wages.  There 
are  some  who  believe  that  wages  are  adjusted  to  the  aver- 
age needs  of  the  workman  ;  and  if  these  needs  increase, 
wages  must  rise.  What  a  man  feels  that  he  must  have,  in 
the  way  of  the  material  necessaries  and  comforts  of  exist- 
ence, is  his  standard  of  living.  This,  according  to  certain 
optimistic  social  philosophers,  he  will  get.  Accordingly, 
if  you  are  modest  in  your  demands,  you  will  receive  a 
modest  stipend ;  if  you  are  convinced  that  the  world  owes 
you  not  only  a  living,  but  a  good  living,  the  world  will 
kindly  accommodate  itself  to  your  view  of  the  matter. 
Certainly,  this  theory  is  a  far  more  agreeable  one,  and  far 
easier  to  grasp,  than  the  laborious  one  presented  in  this 
chapter.      How  much  truth  is  there  in  it? 

If  you  are  planning  to  become  a  physician,  you  are  likely 
to  seek  the  counsel  of  some  who  are  now  practicing  the 
profession.  You  will  probably  receive  some  such  advice 
as  this:  "Whatever  you  do,  don't  make  a  physician  of 
yourself.  A  physician  must  dress  well;  he  must  live 
in  a  good  house;  he  must  keep  a  carriage;  in  short, 
he  must  live  at  great  expense,  and  in  the  majority  of 
cases,  he  will  find  great  difficulty  in  obtaining  an  adequate 


lyo  INTRODUCTION   TO   ECONOMICS 

income."  Now,  what  this  means  is  that  physicians  have  a 
comparatively  high  standard  of  living,  and  that  their  aver- 
age incomes  are  scarcely  sufficient  to  meet  all  the  demands 
upon  them.  You  may  not  be  deterred  by  the  doleful 
account  of  the  physician's  financial  difficulties.  But  is  it 
not  probable  that,  in  the  length  and  breadth  of  the  land, 
hosts  of  young  men  are  in  this  way  turned  to  other  pro- 
fessions .''  If,  on  the  other  hand,  the  majority  of  physicians 
were  recommending  their  profession  as  one  in  which  a 
good  living  is  assured,  is  it  not  likely  that  many  young 
men  would  be  attracted  to  the  profession  .-'  In  the  former 
case  the  average  income  of  the  physician  is  likely  to  be 
increased  by  the  growing  scarcity  of  competent  medical 
men ;  in  the  latter  case  it  is  likely  to  be  decreased  by  in- 
crease in  numbers. 

If,  then,  the  earnings  in  a  profession  or  trade  are  not 
sufficient  to  command,  on  an  average,  the  necessaries  and 
comforts  that  are  deemed  essential  to  happiness,  some  in- 
fluence is  exerted  upon  those  entering  the  profession  or 
trade.  The  standard  of  hving  thus  exerts  some  slight 
influence,  at  least,  upon  wages. 

In  the  example  just  given,  the  effectiveness  of  the  stand- 
ard of  living  in  one  profession  depended  upon  the  absence 
of  a  similar  standard  in  other  professions.  Suppose  that 
after  getting  the  opinion  of  a  physician  as  to  the  advisa- 
bility of  entering  his  profession,  you  apply  to  a  lawyer  for 
his  opinion  on  law  as  a  profession.  "  Whatever  you  do, 
avoid  the  law,"  he  will  probably  tell  you.  Next,  you  go 
to  one  who  has  chosen  journalism.  "  I  pity  a  young  man 
who  selects  journalism  as  his  profession,"  is  probably  what 
you  hear.  Then  you  go  to  a  teacher.  He  shakes  his  head. 
"  If  I  were  a  young  man,  I  should  choose  some  other  pro- 
fession." Indeed,  if  you  do  not  happen  upon  one  of  the 
few  optimists  who  still  survive,  you  are  likely  to  conclude 
that  you  may  as  well  choose  the  profession  toward  which 


COMPETITIVE   WAGES  171 

you  were  originally  inclined,  since  all  the  professions  seem 
to  be  inadequately  paid.  The  fact  is  that  most  of  us  think 
that  we  need  more  than  we  get ;  and  the  result  is  that  no 
one  profession  is  able  to  frighten  aspiring  youths  into 
choosing  some  other  line  of  activity.  The  standard  of 
living  of  any  profession,  therefore,  has  little  effect  upon 
its  average  earnings. 

Suppose,  however,  that  a  whole  nation,  practically,  is 
affected  by  this  feeling  of  discrepancy  between  income 
and  need.  A  considerable  proportion  of  its  young  men 
will  marry  late  or  not  at  all,  children  will  be  few,  and,  if 
immigration  is  not  active,  the,  population  will  gradually 
decline.  In  every  occupation,  men  will  be  withdrawn  from 
the  less  important  tasks  ;  the  less  fertile  fields  and  the  less 
productive  mines  will  be  abandoned.  The  marginal  prod- 
uctivity of  labor,  and  the  average  rate  of  wages,  will  in- 
crease. On  the  other  hand,  if  a  nation  consists  of  people 
who  will  thankfully  receive  little  if  they  cannot  get  much, 
•  who  will  forego  one  luxury  or  comfort  after  another  rather 
than  change  their  traditional  mode  of  life,  no  check  upon 
population  will  exist,  until  the  bare  necessaries  of  existence 
are  insufficient  for  all.  Here,  as  elsewhere,  it  is  because 
the  productivity  of  labor  is  low  that  wages  will  be  low. 
Such  people  will  obtain  only  a  bare  minimum  of  existence, 
because  that  is  all  the  marginal  laborer  is  worth,  not  be- 
cause that  is  all  he  needs. 

We  may  now  sum  up  the  principles  which  we  have 
sought  in  the  foregoing  long  array  of  apparently  unrelated 
examples.  The  marginal  productivity  of  labor  is  under 
competition  the  immediate  determinant  of  wages.  Risk 
or  disagreeableness  of  labor,  the  skill  required,  the  bar- 
riers to  be  surmounted,  the  standard  of  life,  may  all  affect 
the  rate  of  wages,  but  only  in  so  far  as  they  affect  the 
marginal  productivity  of  labor,  through  determining  its 
supply. 


172  INTRODUCTION   TO   ECONOMICS 

16.    Smmnary. 

In  the  widest  use  of  the  term,  wages  include  any  income 
originating  in  labor.  In  a  narrower  sense  wages  are  the 
price  paid  by  one  person  for  another  person's  services. 

While  the  productivity  of  labor  varies  with  the  conditions 
under  which  labor  is  employed,  wages  for  tasks  of  equal 
difficulty  tend  toward  a  uniform  level.  This  level  is  deter- 
mined by  the  addition  to  product  made  by  the  laborers  who 
might  be  most  easily  dispensed  with,  or  the  marginal 
laborers. 

Wages  tend  to  rise  or  fall  with  increase  or  decrease  in 
the  personal  efficiency  of  labor.  An  increase  in  the  labor 
supply,  other  things  equal,  reduces  wages.  Improvements 
in  production  usually  tend  to  raise  wages,  as  does  also 
reduction  in  interest  rates. 

There  is  little  direct  competition  between  laborers  in 
the  several  occupations;  but  the  apportionment  of  the 
supplies  of  new  labor  tend  to  prevent  any  great  inequality 
in  the  rewards  of  men  of  equal  natural  ability.  Permanent 
differences  in  wages  are  the  result  of  barriers  preventing 
the  free  flow  of  labor  from  one  field  to  another,  such  as  a 
long  period  of  apprenticeship,  risk,  trade  union  regulations. 

The  standard  of  living  can  affect  wages  only  through 
reducing  the  supply  of  labor.  When  the  wages  paid  in  a 
given  industry  are  not  high  enough  to  meet  the  require- 
ments of  the  existing  standard  of  living,  young  men  may 
be  discouraged  from  entering  the  industry,  and  hence  wages 
will  tend  to  rise.  W^hen  general  wages  are  inadequate,  in 
view  of  the  general  standard  of  living,  increase  in  popula- 
tion may  be  checked,  and  thus  wages  may  be  raised  to  a 
higher  level. 


CHAPTER    XI 
WAGES   AS   AFFECTED  BY  LABOR   ORGANIZATION 

1.  Where  laborers  arc  not  in  a  position  to  deal  with  their 
employers  on  substantially  equal  terms,  actual  zvagcs  may 
remain  belozv  the  level  fixed  by  marginal  productivity. 

In  the  last  chapter  we  saw  that  under  full  and  free  com- 
petition wages  are  iixed  by  the  productivity  of  labor 
employed  under  the  least  favorable  conditions.  What 
laborers  produce,  in  the  least  productive  fields,  mines,  and 
factories  that  are  actually  under  operation,  sets  the  standard 
toward  which  the  wages  of  all  labor  tend.  In  many -cases, 
however,  actual  wages  fall  below  this  standard.  The  posi- 
tion of  the  laborer  in  bargaining  with  the  employer  is  often 
very  weak.  The  employer  needs  workmen  just  as  the 
laborer  needs  employment ;  but  the  need  of  the  laborer 
is  usually  far  more  pressing  than  that  of  the  employer, 
since  the  former  has  no  adequate  reserve  to  draw  upon 
for  his  living  expenses,  while  the  latter  has  such  a  reserve 
in  his  capital.  Where  industry  is  conducted  on  a  large 
scale,  the  employer  can  without  serious  inconvenience 
dispense  with  the  services  of  any  one  of  his  numerous 
employees.  An  employee,  on  the  other  hand,  cannot 
abandon  his  position  without  running  the  risk  of  a  long 
period  of  unemployment.  Under  the  conditions,  there 
is  every  reason  why  the  labor  contract  should,  in  a  majority 
of  cases,  be  more  favorable  to  the  employer  than  to  the 
employee.  Average  wages  will  be  less  than  the  average 
value  of  labor,  measured  by  marginal  productivity  standards. 

2.  When  the  terms  of  employment  are  fixed,  not  by  agree- 
vfent  betzveen  the  employer  and  individual  xvorkmen,  but  by 

173 


174  INTRODUCTION   TO   ECONOMICS 

agreement  betiveen  the  employer  and  an  organized  body  of 
worhnen,  wages  conform  more  closely  to  productivity 
standards. 

The  disadvantages  under  which  the  workmen  suffer  are 
in  large  measure  removed  by  effective  organization.  The 
employer  may  be  able  to  get  on  very  well  without  the 
services  of  a  particular  employee ;  but  if  all  his  employees 
quit  his  service  at  one  time,  he  is  likely  to  suffer  severe 
losses.  The  employer  may  have  customers  whose  needs 
must  be  supplied,  if  they  are  to  be  kept  from  opening 
business  relations  with  his  competitors.  He  may  have 
notes  falling  due,  which  can  be  renewed  only  if  his  business 
gives  evidence  of  prosperity.  A  prolonged  stoppage  of 
work  may  result  in  the  employer's  ruin ;  in  any  case, 
it  is  likely  to  inflict  serious  injury  upon  him.  Rather  than 
accept  such  an  evil,  he  is  disposed  to  make  concessions 
to  his  employees,  so  long  as  their  demands  do  not  appear 
exorbitant.  Indeed,  there  are  cases  in  which  the  employer 
can  be  compelled  to  pay  his  men  more  than  their  labor  is 
worth,  according  to  the  general  standard  that  the  industry 
can,  in  the  long  run,  afford.  But  these  cases  are  rare,  and, 
in  a  general  study  of  the  effects  of  labor  organization  upon 
wages,  may  be  ignored. 

3.  The  typical  form  of  labor  organization  is  the  trade 
union,  an  association  of  laborers  employed  in  the  same  trade. 

In  a  trade  which  has  become  well  established,  a  natural 
basis  for  organization  is  found  in  the  mutual  sympathy  of 
those  whose  lives  are  passed  under  like  conditions.  One 
carpenter  knows  how  to  evaluate  the  problems  of  life  and 
work  of  another  carpenter.  Even  where  there  is  no  formal 
organization  in  a  trade,  we  find  a  tendency  among  the  mem- 
bers to  work  in  harmony.  They  assist  one  another  in 
finding  work;  members  of  the  trade  who  are  prosperous 
contribute  to  the  support  of  thase  members  who  fall  ill  or 
are    otherwise  overtaken   by  misfortune.      Moreover,  the 


WAGES   AS    AFFECTED   BY   LABOR    ORGANIZATION     175 

typical  workman  is  reluctant  to  underbid  a  fellow-workman 
of  the  same  trade  in  his  dealings  with  an  employer.  Com- 
petition, then,  is  materially  restricted  even  in  trades  with- 
out a  formal  organization. 

With  the  appearance  of  a  class  of  large  employers,  the 
inchoate  organization  of  labor  developed  into  the  formal 
organization  which  we  call  the  trade  union.  In  its  simple 
form,  the  trade  union  is  an  association  of  all,  or  of  a 
large  proportion,  of  the  men  exercising  a  trade  in  a  given 
locality.  The  association  has  regular  meetings  where  the 
conditions  of  employment  are  discussed,  and  rules  are 
adopted  governing  the  conduct  of  members.  Officers  are 
elected  for  the  purpose  of  systematizing  the  work  of  the 
association,  and  of  enforcing  its  rules. 

It  is  rarely  the  case  that  all  persons  in  the  trade  are 
members  of  the  union.  Some  workmen  are  averse  to  the 
restrictions  upon  their  personal  liberty  that  unionism  rep- 
resents ;  some  are  unable  or  unwilling  to  assume  the  finan- 
cial responsibilities  that  membership  entails.  Where  the 
strife  between  the  workers  and  the  employers  is  not  intense, 
the  relations  between  members  of  the  union  and  non-mem- 
bers may  be  entirely  amicable.  The  non-members  work 
alongside  the  members,  and  demand  and  receive  the  same 
wages.  Where  the  union  laborers  are  engaged  in  a  con- 
flict with  their  employers,  they  usually  manifest  hostility 
to  the  non-union  men,  since  the  latter  may  accept  employ- 
ment, to  the  great  injury  of  the  cause  of  the  union,  and  in 
any  event  fail  to  carry  their  fair  proportion  of  the  burden 
of  the  struggle,  though  hoping  to  profit  by  it. 

4.  As  a  matter  of  practical  policy,  a  strong  trade  iDiion 
usually  endeavors  to  induce  all  men  exercising  a  trade  to  be- 
come members  of  tJie  organisation.  Sometimes  union  men 
are  forbidden  to  work  for  employers  xvJw  employ  non-imion 
men.      This  is  knozvn  as  the  "  closed  shop  "  policy. 

It  is  evident  that  the  presence  in  an  industry  of  a  large 


176  INTRODUCTION  TO   ECONOMICS 

number  of  men  who  take  no  part  in  the  existing  laboi 
organization  materially  weakens  the  position  of  the  organi- 
zation. The  union,  therefore,  uses  every  means  to  per- 
suade all  persons  in  the  trade  to  become  members  of  the 
organization.  If  any  refuse,  and  the  union  possesses  the 
necessary  strength,  it  forces  them  to  become  members  by 
harassing  employers  who  admit  the  non-union  men  to 
their  shops.  This  policy  is  often  denounced  by  represent- 
atives of  the  employing  class  as  an  unwarranted  interfer- 
ence in  the  rights  of  the  non-union  men.  It  is  further 
denounced  as  an  attempt  to  compel  the  employer  to  assist 
the  union  in  controlUng  its  membership.  Whether  the 
closed  shop  pohcy  is  justifiable  or  not  depends  entirely 
upon  the  general  policy  of  the  union.  If  it  admits  to 
membership  all  men  having  the  necessary  qualifications 
for  the  work  to  be  done,  upon  payment  of  reasonable 
membership  fees,  it  is  difficult  to  see  how  the  men  who  are 
compelled  to  become  members  have  any  real  grievance. 
So  long  as  the  demands  of  the  union  for  higher  wages  or 
shorter  hours  are  moderate,  the  impartial  outsider  cannot 
censure  the  organization  for  making  its  position  as  strong 
as  possible. 

5.  The  trade  union,  zvhenever possible,  places  limits  Jipon 
the  number  of  persons  admitted  to  the  trade. 

If  the  wages  of  skilled  workmen  in  any  trade  rise  much 
above  the  general  level,  there  is  likely  to  be  an  influx  of 
laborers  from  other  employments,  whose  presence  in  the 
trade  has  the  effect  of  reducing  wages.  In  some  cases  the 
free  admission  to  a  trade  of  all  who  desire  to  exercise  it 
would  reduce  wages  below  the  normal  level.  In  the  build- 
ing trades,  for  example,  wages  appear  to  be  higher  than 
they  really  are.  The  members  of  these  trades  receive 
high  wages  for  the  time  they  are  employed,  but  employ- 
ment is  very  uncertain.  In  the  greater  part  of  the 
country,  the  winter  represents   a  slack  season  in  which 


WAGES   AS   AFFECTED    BY   LABOR    ORGANIZATION     177 

very  few  members  of  the  building  trades  find  steady 
employment.  This  irregularity  of  employment  does  not 
receive  due  consideration  from  young  men  who  are  about 
to  choose  a  trade ;  hence  unrestricted  admission  to  the 
trade  might  easily  depress  annual  earnings  below  the 
normal  level. 

Restrictions  upon  entrance  to  a  trade  may  take  the 
form  of  apprenticeship  regulations  that  are  sufficiently 
onerous  to  reduce  the  number  of  beginners.  Formerly,  a 
seven-year  apprenticeship  was  required  in  many  trades. 
During  the  period  of  apprenticeship,  the  worker  received 
no  wages,  and  this  in  itself  narrowly  limited  the  number 
of  persons  who  could  afford  to  enter  a  trade.  In  some 
trades,  an  apprenticeship  of  three  or  four  years  is  still 
required. 

Another  method  of  limiting  the  number  of  apprentices 
is  to  prescribe  the  proportion  of  apprentices  to  trained 
workmen  that  an  employer  may  have  in  his  shop.  In  the 
job  printing  offices  of  New  York  City,  one  apprentice  is 
allowed  to  every  office  employing  as  many  as  eight  men, 
and  for  every  additional  eight  men  an  additional  appren- 
tice is  allowed  ;  but  no  office  may  employ  more  than  seven 
apprentices.  The  work  that  apprentices  are  allowed  to  do 
is  hedged  about  by  restrictions  that  prevent  the  employer 
from  gaining  much  profit  from  it. 

It  is  easy  to  see  that  through  such  restrictions  upon  ap- 
prenticeship an  artificial  scarcity  of  labor  in  any  one  trade 
may  be  created,  and  wages  may  be  kept  at  an  abnormally 
high  level.  Those  who  are  prevented  from  exercising  the 
trade  are  forced  into  occupations  where  such  limitations 
upon  the  labor  supply  are  impracticable,  thus  depressing 
wages  in  those  occupations.  Consumers  of  the  products 
of  industries  in  which  labor  holds  a  monopolistic  position 
are  forced  to  pay  abnormally  high  prices.  There  are, 
however^   very  few  trades  strong  enough  to    raise  wages 


lyS        .         INTRODUCTION   TO   ECONOMICS 

much  above  the  level  that  the  degree  of  skill  necessary 
would,  in  the  long  run,  command,  even  if  admission  to  the 
trade  were  perfectly  free. 

6.  The  position  of  a  trade  union  is  greatly  strengthened 
by  the  accumulatioji  of  funds  for  the  relief  of  members  in 
time  of  siekness  or  unemployment. 

The  mere  wage  earner  is  at  all  times  exposed  to  the 
danger  of  want  as  a  consequence  of  accident,  sickness,  or 
prolonged  unemployment.  What  he  can  save  individually 
is  seldom  sufficient  to  carry  him  through  a  long  period  of 
time  in  which  he  earns  nothing.  The  trade  union,  by  col- 
lecting contributions  from  those  members  who  are  receiv- 
ing wages,  and  by  distributing  the  money  among  those 
who  are  in  need,  greatly  reduces  the  uncertainties  of  the 
laborer's  lot.  A  plan  of  mutual  insurance  binds  to  the 
union  many  who  would  otherwise  hold  themselves  aloof 
from  it.  Moreover,  it  keeps  those  who  are  out  of  work 
from  offering  their  services  to  the  employer  at  a  reduced 
rate  of  pay,  and  thus  prevents  the  demoralization  of  the 
labor  market. 

But  the  most  important  object  to  be  attained  through  the 
accumulation  of  funds  is  the  strengthening  of  the  union  in 
a  dispute  with  the  employer.  With  a  large  fund,  a  union 
may  be  able  to  keep  its  members  from  accepting  work 
through  a  period  of  several  months  —  long  enough  to  in- 
flict serious  losses  upon  a  recalcitrant  employer.  A  union 
without  funds  may  be  easily  starved  into  submission  to  the 
employer's  conditions. 

7.  The  position  of  a  union  is  strengthened  by  an  alliance 
with  unions  in  related  trades,  or  even  in  unrelated  trades. 

Such  trades  as  the  carpenters,  the  masons,  the  plasterers, 
and  other  building  trades,  have  much  to  gain  through 
working  in  harmony.  At  one  time  the  carpenters  may 
have  a  strong  organization,  and  the  masons  a  weak  one ; 
at  another  time  the  reverse  may  be  true.     On  one  job  a 


WAGES   AS   AFFECTED    BY    LABOR    OROAMZ ATTOX     179 

small  number  of  masons  may  be  needed,  and  a  large  num 
ber  of  carpenters.  In  such  cases,  the  union  masons  could 
perhaps  be  replaced  by  the  non-union  masons  that  are  to  be 
found  in  every  city,- while  it  would  be  more  difficult  to  secure 
a  sufficient  number  of  non-union  carpenters.  The  building 
contractor  must  have  men  of  each  trade,  and  if  he  enc:a<res 
in  a  dispute  with  the  union  whose  position  is  weak,  pressure 
can  be  brought  upon  him  by  the  union  whose  position  is 
strong.  A  harmonious  organization  of  allied  trades  can 
thus  always  place  its  strongest  forces  at  the  front. 

An  advantage  of  a  different  nature  arises  from  an  alliance 
of  unions  in  unrelated  trades.  The  cigar  makers'  union 
can  bring  no  direct  pressure  to  bear  upon  the  employers  of 
garment  workers ;  but  when  the  garment  workers  are 
thrown  out  of  employment  by  a  strike,  the  cigar  makers 
can  contribute  to  their  support.  At  another  time  contribu- 
tions from  the  garment  workers  may  assist  the  cigar  makers 
in  securing  better  terms  from  their  employers. 

In  the  principal  industrial  centers  of  the  United  States, 
both  kinds  of  alliances  are  found.  All  trades  form  a  loose 
organization  known  as  the  Central  Labor  Union  ;  related 
trades,  such  as  the  building  trades,  form  closer  organiza- 
tions, known  under  various  names  in  the  different  cities. 

8.  A  trade  iniioii  in  oiw  locality  is  strengtJiciicd  by  an 
alliance  zvitJi  unions  in  the  same  trade  in  other  localities. 

In  a  period  of  such  easy  communication  as  the  present, 
a  purely  local  labor  organization  can  accomplish  little.  In 
a  dispute  between  the  labor  organization  and  an  employer, 
the  latter  can  cjuickly  import  laborers  from  other  localities 
to  replace  his  former  employees.  Apprenticeship  regula- 
tions in  one  locality  are  enforced  in  vain,  if  in  other  Ipcali- 
ties  the  labor  market  is  overstocked  through  unrestricted 
apprenticeship. 

Even  when  no  importation  of  labor  takes  place,  the  local 
union  finds  difficulty  in  raising  wages  or  reducing  working 


l8o  INTRODUCTION   TO    ECONOMICS 

time.  Such  measures  represent  a  cost  to  the  employer, 
and  if  the  product  is  one  which  must  enter  into  competition 
with  Hke  products  from  other  localities,  the  concessions 
that  the  employer  can  make  to  his  employees  are  narrowly 
limited.  If  the  textile  workers  of  Fall  River  demand 
higher  wages,  the  employers  may  be  unable  to  grant  the 
demand  without  raising  the  price  of  cloth  to  such  an  extent 
as  to  encourage  the  competition  of  other  textile  manufactur- 
ing districts. 

The  importance  of  a  central  organization  appears  nowhere 
more  clearly  than  in  the  case  of  industries  in  which  exten- 
sive consolidations  have  been  formed.  If  the  laborers  in 
one  steel  plant  demand  higher  wages,  the  plant  can  be 
closed  down,  and  the  orders  executed  in  other  works  where 
there  is  no  trouble  with  the  laborers.  The  employer  loses 
practically  nothing,  and  the  laborers  are  in  the  end  com- 
pelled to  return  to  work  on  such  terms  as  the  employer 
may  dictate. 

In  any  event  an  organization  covering  a  wide  range  of 
territory  affords  an  excellent  means  of  raising  funds  for 
local  organizations  in  time  of  labor  disputes.  When  the 
cigar  makers  of  New  York  are  on  strike,  the  cigar  makers 
in  Philadelphia,  Boston,  Chicago,  and  other  cities  raise 
funds  for  their  support. 

The  foregoing  considerations  have  led  to  the  formation 
of  national  or  international  unions  in  almost  every  impor- 
tant trade.  In  government  these  organizations  are  some- 
times loose  federations,  sometimes  strongly  centralized 
bodies.  In  the  centralized  unions  the  local  union  is  re- 
quired to  obtain  the  consent  of  the  national  union  before 
inaugurating  a  strike  ;  the  national  officers  can  call  a  strike 
in  any  locality,  even  if  the  members  of  the  local  organiza- 
tion are  content  with  their  condition.  The  essence  of  the 
power  of  the  national  union  is  its  control  over  the  funds 
that   are    accumulated   for    emergencies,     A    local    union 


WAGF:S    as   AFFFXTED    BV    labor    ORdAXlZAriON      i8i 

which  goes  on  strike  without  proper  authorization  forfeits 
its  claim  for  strike  benefits  from  the  national  organization  ; 
a  local  union  which  refuses  to  strike  when  ordered  to  do  so 
is  suspended  or  expelled  from  the  national  union,  and  is 
subjected  to  more  or  less  severe  discipline  before  it  is  rein- 
stated in  the  organization. 

9.  National  ors;anizatio}ts  Jiai'e  inncJi  to  (:'aiii  tJirouo;h  a 
central  organization  covering  the  ivJiole  field  of  indiistrj. 

In  the  United  States  most  of  the  national  unions  are 
associated  in  a  great  central  organization  known  as  the 
American  Federation  of  Labor.  This  organization  fur- 
nishes a  means  by  which  the  support  of  the  entire  trade- 
union  world  may  be  given  to  unions  engaged  in  an  extended 
contest  with  their  employers.  The  American  Federation 
pretends  to  no  direct  control  over  its  constituent  members, 
but  unions  about  to  engage  in  a  labor  disjnite  naturally 
consult  with  the  officers  of  the  Federation  and  seek  the 
cooperation  of  that  body.  The  American  Federation  col- 
lects information  relating  to  the  entire  field  of  labor  and 
assists  in  organizing  unions  in  new  fields.  When  disputes 
arise  between  different  labor  organizations,  the  Ameri- 
can Federation  officials  act  as  arbitrators  ;  when  factional 
strife  causes  the  disruption  of  a  union,  the  officers  of  the 
Federation  are  active  in  effecting  a  reorganization.  With 
the  lapse  of  time  the  American  Federation  will  probably 
gain  additional  strength,  and  will  demand  a  voice  in  all 
questions  of  general  importance  to  the  laboring  class. 

10.  The  principal  zvcapon  in  the  Jiands  of  organized  labor 
IS  the  strike.  A  strike  is  a  concerted  suspension  of  zvork 
for  the  purpose  of  enforcing  some  demand  upon  the  em- 
ployer. 

Sometimes  the  mere  fact  that  demands  are  presented  to 
the  employer  by  an  organization  including  his  entire  work- 
ing force  leads  to  concessions  that  would  never  be  made 
to  isolated  employees.     In  many  cases,  however,  the  em- 


l82  INTRODUCTION   TO    ECONOMICS 

ployer  refuses  to  consider  the  demands  of  his  employees, 
and  a  strike  is  called.  It  is  possible  that  the  employer 
would  be  unable  to  grant  the  demands  even  if  he  desired 
to  do  so.  In  perhaps  a  majority  of  instances  the  demands 
could  be  granted  in  part  or  wholly  without  serious  loss 
to  the  employer.  At  all  events  the  laborers  believe  this, 
and  in  suspending  work  they  feel  that  they  are  merely 
stopping  operations  long  enough  to  reach  a  satisfactory 
adjustment  of  the  matters  in  dispute.  Sometimes  the 
employer  takes  the  same  view  of  the  riiatter  and  makes 
no  attempt  to  replace  his  striking  workmen. 

If  the  employer  feels  that  the  demands  of  the  men  are 
wholly  unreasonable,  he  is  likely  to  attempt  to  fill  the 
places  left  vacant  with  laborers  who  are  not  controlled  by 
the  organization  of  the  strikers.  This  the  latter  must  pre- 
vent, if  they  are  to  have  any  chance  of  winning.  If  there 
is  nowhere  to  be  found  an  adequate  number  of  laborers 
willing  to  work  as  strike  breakers,  the  strikers  may  be 
content  to  allow  the  employer  to  experiment  with  ineffi- 
cient men.  If  the  efforts  of  the  employer  to  secure 
laborers  appear  to  be  successful,  the  strikers  endeavor  to 
persuade  the  strike-breaking  laborers  to  join  in  the  sus- 
pension of  work.  "Pickets"  are  stationed  at  the  en- 
trance to  the  works,  to  inform  all  men  coming  to  their 
tasks  that  a  strike  is  in  progress.  If  the  strike  breakers 
do  not  yield  to  peaceable  persuasion,  the  pickets  often 
resort  to  intimidation.  Where  the  contest  becomes  very 
bitter,  the  strikers  sometimes  employ  violence  to  frighten 
the  strike  breakers  from  their  work.  The  employment  of 
violence  is  discountenanced  by  the  leaders  of  the  strike ; 
nevertheless,  a  great  strike  has  seldom  been  entirely  free 
from  instances  of  injury  inflicted  upon  strike  breakers. 

11.  A  second  weapon  of  organized  labor  is  the  boycott. 
A  boycott  is  an  association  having  for  its  purpose  the  destruc- 
tion of  the  business  of  an  employer  through  pressure  brought 


wagp:s  as  affected  JJY  EABC^R  ORGAXIZAIKJX     183 

to  bear,  directly  or  indirectly,  upon  those  wJio  have  business 
relations  ivith  him. 

When  men  are  on  strike,  they  naturally  refrain  from 
purchasing  the  products  of  their  former  employer,  and 
persuade  their  friends  to  follow  the  same  course  of  action. 
This  is  a  simple  form  of  the  boycott ;  it  may  be  fairly 
effective  when  the  product  is  destined  for  local  consump- 
tion by  the  working  class.  An  employing  baker,  for 
example,  may  be  brought  to  terms  in  this  way.  Where 
the  product  is  placed  upon  a  general  market  the  boycott 
takes  a  more  complex  form.  The  Avhole  trade-union 
world  may  be  warned  not  to  buy  the  products  of  the 
offending  employer.  This  may  be  done  through  the  pub- 
lication in  the  trade  journals  of  the  name  of  the  employer 
who  is  the  subject  of  attack.  For  a  long  time  an  "unfair 
list,"  a  list  of  the  names  of  such  employers,  was  published 
by  the  organ  of  the  American  Federation  of  Labor.  This 
form  of  boycott  has  been  held  by  the  courts  to  be  illegal, 
but  it  is  practically  impossible  to  do  away  with  it. 

Sometimes  the  boycott  takes  a  very  roundabout  course. 
A  merchant  is  boycotted  for  handling  the  products  of  an 
"  unfair  "  shop  ;  laborers  are  boycotted  for  buying  goods 
from  such  a  merchant ;  men  who  employ  these  laborers 
are  boycotted,  and  so  on.  These  roundabout  boycotts 
are  not  very  frequent  nor  very  important.  They  are  of 
doubtful  value  to  the  laborers'  cause,  as  they  inflict  more 
hardship  upon  innocent  parties  than  upon  the  persons 
against  whom  they  are  ultimately  directed. 

12.  Strikes  and  boycotts  may  be  carried  on  by  zvorknien 
who  have  no  formal  organisation. 

We  have  spoken  of  strikes  and  boycotts  as  the  weapons 
of  organized  labor.  As  a  fact,  however,  a  great  many 
strikes  take  place  in  trades  that  are  not  organized  in 
unions.  For  the  purpose  of  carrying  on  a  strike  a  tem- 
porary organization  is  effected  which  may  be  abandoned 


i84  INTRODUCTION   TO   ECONOMICS 

when  the  strike  is  won  or  lost.  Boycotts,  under  one  name 
or  another,  have  often  been  employed  by  unorganized 
laborers. 

Even  in  an  organized  trade  it  often  happens  that  the 
non-union  men  join  the  union  men  in  striking.  This  was 
the  case  in  the  last  strike  of  the  Fall  River  textile  workers 
and  of  the  anthracite  coal  miners.  In  such  cases  the  or- 
ganized laborers  usually  assume  the  leadership. 

It  is  not  certain  whether  the  formation  of  trade  unions 
leads  to  an  increase  or  to  a  reduction  in  the  number  of 
strikes.  It  is  undoubtedly  true  that  a  permanent  organ- 
ization results  in  a  reduction  in  the  number  of  strikes 
having  no  adequate  cause.  A  trade  union  develops  re- 
sponsible leaders  who  do  everything  in  their  power  to 
prevent  a  strike  when  the  chances  of  winning  are  small. 

13.  In  iiiatiy  trades  zvhcre  poxverful  organizations  have 
been  established,  the  terms  of  employment  are  fixed,  not  by 
bargaining  between  the  employer  and  the  individual  ivork- 
men,  but  by  agreements  betzvcen  representatives  of  the 
laborers,  on  the  one  hand,  and  representatives  of  the  employers, 
on  the  other.  This  plan  of  fixing  the  terms  of  employment 
is  knoivn  as  colleetive  bargaining. 

In  the  bituminous  coal  district  of  the  North  Central 
states  representatives  of  the  miners  and  representatives  of 
the  mine  operators  meet  annually  to  determine  the  rate 
of  wages  to  be  paid.  In  these  meetings  all  the  circum- 
stances of  the  industry  are  fully  discussed,  —  the  prices 
that  the  product  is  likely  to  command,  the  cost  of  placing 
it  on  the  market,  the  cost  of  living  of  the  workmen,  the 
wages  paid  in  other  districts,  etc.  As  a  result  of  the  dis- 
cussion each  side  gains  a  fairly  clear  understanding  of  the 
position  of  the  other.  It  becomes  impossible  for  the  la- 
borers to  insist  upon  terms  that  the  employers  cannot 
possibly  grant,  as  not  infrequently  happens  where  no 
machinery  for  collective  bargaining  has  been  established. 


WAGES   AS   AFFECTED    BY    LABOR    ORGANIZATION     185 

Differences  of  opinion  as  to  what  constitutes  a  fair  wage 
naturally  arise ;  but  through  full  discussion  and  mutual 
concessions  these  differences  are  prevented  from  causing  a 
rupture  of  negotiations.  Since  the  adoption  of  the  plan  of 
joint  conferences  agreements  have  always  been  reached, 
and  have  in  most  cases  been  loyally  observed  by  both  em- 
ployers and  employed. 

In  a  number  of  other  American  industries  similar  meth- 
ods of  collective  bargaining  are  employed,  and  in  England, 
where  trade  unionism  is  more  powerful  than  in  any  other 
country,  all  the  great  industries  establish  the  conditions  of 
employment  by  collective  bargaining. 

It  is  clear  that  in  a  complex  modern  industry,  only  the 
more  general  conditions  of  employment  can  be  fixed  by 
such  agreements.  Minor  disputes  will  constantly  arise 
relating  to  the  interpretation  of  the  general  agreement. 
Provision  is  usually  made  for  the  settlement  of  such  dis- 
putes by  a  committee  representing  both  the  workmen  and 
the  employers.  Where  such  a  committee  is  unable  to 
reach  a  decision,  resort  is  had  to  the  services  of  an  impar- 
tial outsider  who  acts  as  arbitrator. 

In  some  industries  there  is  a  general  understanding  that 
if  no  a2:reement  as  to  the  renewal  of  the  contract  can  be 
reached,  the  matters  in  dispute  shall  be  settled  by  arbitra- 
tion. Such  arbitration,  however,  is  not  always  successful, 
since  either  the  laborers  or  the  employers  may  prefer  to 
submit  to  a  trial  of  strength  rather  than  accept  the  onerous 
conditions  of  the  arbitrators'  award. 

14.  W//eu  a  strike  has  been  in  progress  for  a  long  time, 
and  both  parties  to  the  dispute  are  thoroughly  ivearied  ivith 
it,  though  either  is  innvillitig  to  surrender  its  claims,  resort 
may  be  had  to  arbitration. 

In  perhaps  a  majority  of  the  important  strikes  of  recent 
years  each  party  to  the  controversy  has  taken  a  position 
which  is  not  wholly  defensible.     The  demands  of  the  men 


t86  introduction   TO   ECONOMICS 

are  excessive,  and  the  terms  that  the  employer  insists  upon 
are  unnecessarily  onerous  to  the  men.  Negotiations  are 
broken  off  and  a  strike  follows,  to  the  serious  injury  of  both 
parties.  As  the  burdens  of  the  struggle  grow  heavier, 
each  party  sees  that  its  original  position  was  untenable, 
but  shrinks  from  making  concessions,  fearing  that  to  do 
so  would  be  to  confess  itself  worsted  in  the  struggle. 
The  only  way  in  which  the  difficulty  can  be  settled  without 
loss  of  prestige  to  either  party  is  through  submission  of  the 
matters  in  dispute  to  arbitrators  mutually  agreed  upon. 
Both  parties  bind  themselves  to  accept  the  award  of 
the  arbitrators  in  good  faith,  and  instances  are  rare  in 
which  this  agreement  is  disregarded.  The  award  of  the 
arbitrators  is  seldom  anything  more  than  a  balancing  of 
concessions  ;  it  usually  satisfies  neither  party,  but  is  ac- 
cepted as  a  lesser  evil  than  a  continuance  of  the  struggle. 

15.  Arbitration  may  be  forced  upon  the  parties  to  an  in- 
dustrial dispute  by  the  pressure  of  public  opinion. 

While  the  persons  most  seriously  injured  by  the  continu- 
ance of  an  industrial  dispute  are  the  laborers  and  employ- 
ers directly  involved,  no  important  strike  can  be  conducted 
without  injury  to  the  public.  In  the  Chicago  teamsters'  strike 
of  1905,  while  the  losses  to  the  strikers  and  the  employers 
were  estimated  at  about  ^3,000,000,  the  loss  to  the  business 
men  of  the  city  was  estimated  at  several  times  that  amount. 
A  strike  of  railway  laborers  almost  inevitably  injures  inno- 
cent parties  more  than  it  injures  the  railway  companies 
against  which  the  strike  is  directed.  The  blocking  of  the 
street  railway  system  of  a  great  city  through  a  strike  in- 
flicts immeasurable  injury  upon  the  general  public.  The 
anthracite  coal  strike  of  1902  occasioned  great  distress 
among  the  poorer  classes  of  those  parts  of  the  country 
that  are  dependent  upon  anthracite  coal  for  fuel ;  the  re- 
sulting high  price  of  coal  caused  the  closing  down  of  many 
shops  and  factories  with  consequent  losses  in  wages  and 


WAGES   AS   AFFECTED   BY   LABOR   ORGANIZATION     187 

profits.  In  almost  every  great  strike  instances  of  violence 
are  frequent,  and  the  charges  upon  the  public  for  mamtain- 
ing  the  peace  are  greatly  increased. 

Accordingly  there  arc  the  best  reasons  why  persons 
representing  the  interests  of  the  public  should  undertake 
the  task  of  bringing  about  a  reconciliation  between  the 
employers  and  their  striking  employees.  In  some  cases 
those  who  undertake  this  task  limit  themselves  to  inducing 
the  disputants  to  meet  in  conference  to  discuss  the  matters 
at  issue.  This  may  of  itself  lead  to  a  settlement  of  the 
dispute.  Such  intervention  is  known  2i^  conciliation.  In 
other  cases  an  attempt  is  made  to  force  the  disputants  to 
submit  to  arbitration.  Thus  in  the  coal  strike  of  1902  Presi- 
dent Roosevelt  induced  the  coal  mine  operators  and  the 
miners  to  submit  the  dispute  to  an  arbitration  commission 
appointed  by  himself.  In  a  similar  manner  Governor 
Douglas,  of  Massachusetts,  effected  a  settlement  of  the 
Fall  River  strike  of  1904. 

16.  //  ivoiild  be  a  great  gain  to  society  if  industrial  dis- 
putes  could  be  submitted  to  arbitration  as  soon  as  they  arise, 
instead  of  tozvard  the  close  of  a  long  contest. 

No  argument  is  necessary  to  show  that  a  strike  is  a 
wasteful  way  of  establishing  the  conditions  of  employment. 
Since  a  settlement  is  likely  to  be  effected  by  arbitration, 
why  is  a  long  and  expensive  struggle  necessary  }  Why  do 
not  the  disputants  resort  to  arbitration  at  the  outset  ? 

In  most  cases  an  industrial  dispute  is  based  upon  irrecon- 
cilable differences  of  opinion.  The  employer  offers  what 
he  considers  the  fairest  terms  he  can  afford  to  give ;  he 
believes  that  the  laborers  will  be  compelled  to  accept  these 
terms  in  the  end.  The  laborer  demands  what  he  regards 
as  the  lowest  wages  that  he  can  accept  in  the  circum- 
stances ;  he  believes  that  the  employer  will  in  the  end  be 
compelled  to  concede  his  demands.  Arbitration  would 
almost  certainly  result  in  terms  that  each  party  to  the  con- 


i88  INTRODUCTION   TO   ECONOMICS 

troversy  would  regard  as  unfair  to  itself.  Consequentl)) 
each  party  prefers  to  resort  to  a  trial  of  strength.  After 
the  struggle  has  continued  for  some  time,  and  each  party 
has  gained  an  insight  into  the  real  strength  of  the  other, 
the  necessity  of  mutual  concession  becomes  apparent  to 
every  one  concerned.  Terms  that  would,  at  the  outset, 
have  been  spurned  by  both  parties  can  be  accepted,  though 
perhaps  reluctantly,  by  both  the  employer  and  the  employee. 

It  is  accordingly  clear  why  a  plan  of  purely  voluntary 
arbitration  is  ineffective  as  a  means  for  preventing  strikes. 
Many  of  our  stages  have  created  commissions  or  boards  of 
arbitration  with  authority  to  settle  industrial  disputes  upon 
the  application  of  both  contestants.  The  services  of  these 
officials  are  not  often  requested. 

In  New  Zealand  employers  and  organized  laborers  are 
required  by  law  to  settle  their  disputes  without  recourse  to 
strikes.  The  colony  is  divided  into  districts  in  each  of 
which  a  board  of  conciliation  exists  which  is  authorized  to 
inquire  into  all  labor  disputes  with  the  purpose  of  effecting 
a  settlement  by  mutual  agreement.  If  the  parties  to  the 
dispute  cannot  be  brought  to  an  agreement,  the  dispute  is 
referred  to  the  court  of  arbitration,  which  hears  both  sides 
and  renders  a  decision  which  is  binding.  Under  the  New 
Zealand  system  the  strike  has  been  eliminated.  Whether 
such  a  system  would  be  satisfactory  under  the  complex 
conditions  of  American  industry  is  somewhat  doubtful. 
In  this  country  comp-ulsory  arbitration  is  regarded  with 
disfavor  both  by  employers  and  by  organized  labor. 

17.  TJie  organization  of  labor  modifies  the  operation  of  the 
competitive  law  of  wages,  but  does  not  subvert  that  law. 

It  has  often  been  noted  that  in  times  of  prosperity  labor 
organizations  are  usually  able  to  force  a  rise  in  wages ;  in 
times  of  depression  such  organizations  are  unable  to  check 
a  decline  in  wages.  In  times  of  prosperity  the  trend  of 
wages,  both  of  organized  and  of  unorganized  labor,  is  up- 


WAGES   AS   AFFECTED   BY   LABOR   ORGANIZATION     189 

ward  ;  in  times  of  depression  it  is  downward.  In  economic 
terms  prosperity  means  an  increase  in  the  value  product 
of  labor,  and  the  laws  of  competition  compel  the  employers 
to  raise  wages  accordingly.  Depression  means  a  reduction 
in  the  value  product  of  labor,  and  hence  results  in  a 
reduction  in  wages. 

But  the  competition  of  employers  is  never  very  acute, 
and  for  a  long  time  they  may  fail  to  raise  wages,  although 
the  general  circumstances  of  industry  justify  higher 
wages.  It  is  only  as  increased  profits  lead  to  an  expansion 
of  industrial  operations  and  an  increased  demand  for  labor 
that  the  competition  of  employers  takes  the  form  of  an 
increase  in  wages.  Labor  organization  may  force  an  ad- 
vance in  wages  long  before  the  competition  of  employers 
would  lead  to  the  same  result.  By  virtue  of  organization 
the  laborer  shares  more  promptly,  and  probably  more  liber- 
ally, in  the  increased  productivity  of  industry  than  he  would 
if  he  relied  upon  his  individual  bargaining  power. 

While  we  must  grant  to  labor  organizations  an  impor- 
tant influence  in  maintaining  a  high  level  of  wages,  we 
must  not  forget  that  this  influence  may  easily  be  over- 
estimated. Wages  are  higher  in  America  than  in  England, 
not  because  our  labor  organizations  are  stronger  than 
those  of  England,  —  for  the  reverse  is  true,  —  but  because 
labor  is  more  productive  in  this  country  than  in  England. 
Wages  will  remain  at  a  high  level  in  this  country  so  long 
as  the  high  productivity  of  labor  is  maintained ;  and  no 
form  of  organization  can  long  maintain  wages  in  the  face 
of  declining  productivity. 

18.  In  so  far  as  labor  organisations  tend  to  reduce  the 
efficiency  of  labor,  their  ultimate  effect  upon  wages  is 
injurious. 

Labor  organizations  do  not  always  confine  themselves 
to  the  function  of  securing  the  highest  pay  for  a  given 
service ;  in  many  cases  they  endeavor  to  reduce,  as  far  as 


190  INTRODUCTION   TO    ECONOMICS 

possible,  the  service  rendered  for  a  given  wage.  They  en- 
deavor to  reduce  the  number  of  hours  in  the  working  day ; 
they  place  checks  upon  the  amount  of  work  that  each  man 
may  turn  out  in  a  day ;  they  sometimes  discourage  the 
introduction  of  devices  that  increase  the  effectiveness  of 
labor.  These  policies  do  not  always  result  in  a  reduction 
in  productivity.  In  the  long  run  a  laborer  may  be  able  to 
accomplish  more  in  an  eight-hour  day  than  in  a  ten-hour 
day.  Excessive  speed  may  quickly  wear  the  laborer  out, 
and  render  him  incapable  of  performing  tasks  of  a  high 
degree  of  importance.  So  far  as  labor  organization  limita- 
tions lead  to  a  conservation  of  the  energies  of  the  work- 
man, they  increase  the  productivity  of  labor,  in  the  long 
run,  and  make  possible  an  advance  in  wages. 

Instances,  however,  are  not  lacking  of  restrictions  that 
aim  at  compelling  the  employer  to  increase  the  number  of 
men  employed  for  the  performance  of  a  given  amount  of 
work.  Many  laborers  cherish  the  illusion  that  society 
offers  only  a  definite  amount  of  employment,  and  that  if 
one  man  increases  the  measure  of  his  performance,  h6 
takes  employment  away  from  some  other  man.  An  entire 
laboring  class  may  become  infected  with  this  fallacious 
view,  and  everywhere  reduce  efficiency  to  its  lowest  terms. 
Sooner  or  later  employers  find  themselves  unable  to  pay 
the  existing  rate  of  wages ;  if  the  organization  is  power- 
ful enough  to  prevent,  for  a  time,  a  reduction  in  wages, 
employers  reduce  their  working  force;  an  "army  of  the 
unemployed  "  is  created ;  and  in  the  end  the  organization 
breaks  down  under  the  competition  of  the  laborers  ex- 
cluded from  employment. 

19.    Sinmnary. 

The  individual  workman  is  often  at  a  serious  disadvantage 
in  bargaining  with  his  employer;  hence  wages  will  often 
be  less  than  the  worth  of  the  laborer's  services.  This  in- 
equahty  may  be  corrected  by  an  organization  of  workmen, 


WAGES   AS    AFFECTED    BY   LABOR    ORGANIZATION     191 

all  of  whom  present  their  demands  upon  the  employer 
simultaneously. 

The  trade  union  is  an  association  composed  of  workmen 
employed  in  the  same  trade.  When  such  an  organization 
is  formed  an  attempt  is  made  to  induce  all  the  men  practic- 
ing the  trade  to  become  members.  After  the  organization 
gains  practical  control  of  a  trade,  it  usually  endeavors  to 
limit  the  number  of  men  admitted  to  the  trade,  in  order  to 
maintain  a  high  level  of  wages. 

A  trade  union's  position  is  greatly  strengthened  if  it 
undertakes  the  relief  of  its  members  in  time  of  sickness, 
accident,  or  unemployment.  The  principal  function  of 
trade  union  accumulations  is  the  maintenance  of  the 
members  of  the  union  in  time  of  strike.  Each  local  union, 
further,  is  greatly  strengthened  by  alliances  with  other 
unions  in  the  same  locality  or  in  other  parts  of  the  country. 

The  chief  weapons  of  the  trade  union  are  the  strike  and 
the  boycott.  Where  trade  unions  are  strong  they  are  often 
able  to  make  satisfactory  terms  with  their  employers  with- 
out resort  to  the  strike.  In  many  cases  the  terms  of  em- 
ployment are  established  by  agreement  between  the  em- 
ployers on  the  one  hand  and  representatives  of  the  trade 
union  on  the  other. 

Disputes  between  employers  and  workmen  are  some- 
times settled  by  arbitration.,  without  resort  to  a  strike.  In 
cases  of  prolonged  struggles  between  employers  and  em- 
ployees, public  opinion  may  compel  a  submission  of  the 
matters  in  dispute  to  arbitration.  In  New  Zealand  all 
disputes  between  employers  and  organized  laborers  must 
be  settled  by  arbitration. 

Labor  organizations  increase  general  wages  in  so  far  as 
they  prevent  the  employer  from  taking  advantage  of  the 
weakness  in  bargaining  of  the  individual  workman,  and  in 
so  far  as  they  increase  the  efficiency  of  labor.  Through 
restrictions  upon  output  they  sometimes  reduce  the  prod- 
uctivity of  labor  and  so  tend  to  reduce  general  wages. 


CHAPTER   XII 

THE   PRODUCTIVITY  OF   CAPITAL 

1.  The  term  '^  capital  goods  "  may  be  employed  to  designate 
objects  of  wealth  tJiat  yield  an  income. 

Men  who  are  engaged  in  business  commonly  divide 
their  material  possessions  into  two  classes ;  those  that 
are  held  for  the  money  income  they  yield,  and  those  that 
are  held  for  the  immediate  satisfaction  they  afford.  The 
objects  composing  a  merchant's  stock  in  trade,  his  build- 
ings and  fixtures,  belong  to  the  former  class.  The  mer- 
chant's watch,  the  clothes  he  wears,  the  horse  he  rides 
for  recreation,  belong  to  the  latter  class.  The  former 
class  we  shall  call  "  capital  goods " ;  the  latter,  "  con- 
sumer's goods."  When  a  man  buys  capital  goods,  he  is 
commonly  said  to  "invest  money."  When  he  buys  con- 
sumer's goods,  he  is  said  to  "  spend  money." 

The  distinction,  it  is  true,  is  not  so  easily  drawn  as 
might  at  first  appear.  Is  a  man's  house  to  be  classed  with 
his  capital  goods  t  The  income  that  it  affords  is  primarily 
one  of  satisfaction,  like  that  afforded  by  a  watch  or  a 
saddle  horse.  The  possession  of  a  house  saves  the  pay- 
ment of  rent,  and  to  this  extent  adds  to  one's  disposable 
income. 

Reflection  will  show,  however,  that  goods  yielding  an 
income  of  direct  satisfaction  are  normally  distinguished  by 
their  owners  from  goods  yielding  a  money  return.  The 
standards  governing  purchases  of  goods  for  business  pur- 
poses are  adequacy  and  sureness  of  return  ;  the  standard 
governing  purchases  of  goods  serving  personal  uses  is 
what  one  can  afford.  A  home  is  seldom  strictly  a 
"  business  proposition,"  and  for  this  reason  may  usually  be 

192 


THE   PRODUCTIVITY   OF   CAPITAL  193 

excluded  from  the  rank  of  capital  goods.  And  the  same 
thing  is  true  of  other  goods  yielding  an  income,  not  of 
money,  but  of  satisfaction. 

2.  TJie  permanent  fund  of  productive  wealth  which  capital 
goods  represent  is  knoivn  as  capital. 

The  great  majority  of  capital  goods  are  perishable  in 
their  nature.  The  capital  goods  of  a  merchant,  so  far  as 
they  consist  of  merchandise,  are  destined  in  a  very  short 
time  to  pass  into  the  hands  of  the  merchant's  customers, 
where  they  cease  to  be  capital  goods.  So  far  as  they 
consist  of  buildings  and  fixtures,  they  may  endure  a  gener- 
ation or  more;  but  in  the  end  the  buildings  depreciate  and 
the  fixtures  become  antiquated.  It  would  be  next  to  impos- 
sible to  find  a  business  establishment  which  has  precisely 
the  same  capital  goods  it  had  a  year  ago.  It  is  an  easy 
matter  to  find  an  establishment  which  is  said  to  have  the 
same  capital  that  it  had  a  year  ago.  A  merchant  starts  in 
business  to-day  with  a  capital  of  $100,000  invested  in 
building  and  stock.  At  the  end  of  a  year  we  ask  him 
what  his  capital  then  is.  Very  likely  it  will  still  be 
$100,000.  Now,  is  this  the  same  capital,  or  is  it  a  new 
one }  The  merchant  certainly  will  say  that  it  is  the  same 
capital  —  unless,  of  course,  he  has  lost,  in  the  course  of 
the  year,  his  original  capital  and  has  replaced  it  from  some 
new  source.  But  how  can  the  capital  be  the  same  after 
the  lapse  of  a  year  f  Nearly  all  the  things  that  figured  in 
the  first  inventory  except  the  building,  have  been  replaced, 
in  the  second  inventory,  by  objects  which  may  be  of  a 
quite  different  character.  In  the  first  inventory,  perhaps, 
cheap  grades  of  goods  preponderate ;  in  the  second  these 
may  be  largely  replaced  by  higher  grades.  However  this 
may  be,  there  can  be  no  denying  that  the  goods  have 
changed,  yet  the  merchant  says  that  the  capital  is  the 
same. 

Perhaps  we  are  making  ourselves  unnecessary  diiTficul* 


194  INTRODUCTION   TO   ECONOMICS 

ties  in  our  endeavor  to  arrive  at  the  merchant's  meaning 
when  he  says  that  his  capital  remains  the  same  even  after 
most  of  the  things  originally  composing  it  have  left  his  pos- 
session. Possibly  he  means  simply  that  he  has  as  large  a 
capital  at  one  time  as  at  another.  Two  things  that  are 
equal  in  magnitude  are  of  course  not  the  same  thing,  but 
we  often  speak  of  them  as  if  they  were. 

Yet  if  we  reflect  upon  it,  this  does  not  appear  to  be  what 
the  business  man  means.  Suppose  that  fire  or  flood  had 
destroyed  his  store  and  stock,  and  that  a  rich  relative,  to 
set  him  on  his  feet  again,  had  given  him  $100,000  to  re- 
place them.  The  merchant  would  not  say  that  he  was 
continuing  in  business  with  the  same  capital,  although  in 
magnitude  it  would  be  the  same.  Clearly,  a  business  man 
thinks  of  his  capital  as  something  that  is  capable  of  remain- 
ing permanently  the  same  although  the  goods  that  compose 
it  are  constantly  changing.  The  popular  definition  of 
capital  is  a  fund  of  productive  wealth,  which  has  the  power 
of  self-perpetuation.  This  definition  we  may  accept  as  one 
of  the  simplest  that  have  been  proposed. 

3.  The  permanence  of  capital  depends  upon  the  economic 
pozver  of  capital  goods  to  replace  tJieir  value  either  through 
sale  or  thro7igh  assistance  rejidet'ed  in  production. 

An  enterpriser  possessing  $100,000  in  cash  proposes  to 
establish  a  clothing  store.  The  first  thing  he  must  do  is  to 
find  a  place  where,  he  has  reason  to  believe,  the  goods 
in  which  he  proposes  to  deal  will  sell  at  a  higher  price 
than  that  which  he  must  pay  for  them.  This,  of  course,  is 
comparatively  easy  to  do.  Goods,  as  they  come  from 
the  factory,  may  in  a  physical  sense  be  ready  for  use ;  eco- 
nomically, however,  much  remains  to  be  done  before  they 
can  be  placed  where  they  will  fulfil  their  ultimate  purpose 
—  the  direct  satisfaction  of  human  wants.  They  must  be 
conveyed  to  places  where  they  are  accessible  to  the  con- 
sumer ;  they  must  be  so  arranged  that  inspection  is  easy. 


THE   PRODUCTIVITY    OF    CAPITAL  195 

Expert  clerks  must  be  at  hand  to  point  out  their  good  quali- 
ties and  explain  away  their  bad  ones.  This  means  that  a 
considerable  addition  to  the  value  of  goods  may  be  made 
after  they  have  left  the  factory  ;  and  this  addition,  properly 
speaking,  is  the  product  of  the  mercantile  establishment. 

Each  item  of  the  stock  normally  sells  at  a  price  which 
will  at  least  replace  that  item  with  one  of  equal  value,  to- 
gether with  a  surjDlus  which  will  cover  the  cost  of  labor 
employed  in  handling  it,  and  which  will  also  make  some  con- 
tribution to  the  expense  of  keeping  up  the  building.  Any 
item  which  does  not  do  this  is  carried  at  a  loss  ;  and  a  busi- 
ness man  who  should  continue  to  carry  such  items  would 
see  his  capital  diminish,  and  perhaps  ultimately  disappear. 
Some  parts  of  the  stock  may  afford  a  far  larger  surplus,  and 
the  aggregate  income  of  the  establishment  may  be  much 
more  than  enough  to  keep  stock  and  store  intact,  after 
paying  for  all  human  services  directly  employed.  The 
nature  of  this  excess  of  income  above  outlay  we  shall  con- 
sider at  a  later  point.  For  the  present  we  are  concerned 
primarily  with  the  fact  that  the  first  demand  upon  the 
business  is  that  each  item  shall  maintain  itself  —  i.e., 
through  sale,  reproduce  itself  together  with  auxiliary  costs 
connected  with  it. 

It  must  now  be  clear  how  it  is  that  a  fund  of  capital 
persists.  Each  capital  good,  before  it  is  sold  or  worn  out, 
produces  a  sum  of  value  that  enables  the  owner  of  the  good 
to  purchase  or  make  another  good  of  the  same  character, 
which  in  its  turn  possesses  the  power  of  replacing  itself  by 
a  successor  of  equal  value.  The  capital  goods  of  this  year 
are,  therefore,  not  merely  the  successors  in  time  of  those  of 
last  year,  now  mostly  destroyed  ;  they  are,  economically, 
the  offspring  of  the  capital  goods  of  the  earlier  period,  and 
they  have  the  same  power  of  replacing  themselves  with 
other  goods  having  the  power  of  self-replacement. 

It  is,  of  course,  to  be  understood  that  this  self-replace- 


196  INTRODUCTION   TO    ECONOMICS 

ment  is  neither  automatic  nor  inevitable.  We  may  say  that 
under  certain  conditions  a  particular  capital  good  will  add 
something  to  the  total  product  of  an  industry,  but  not  enough 
to  keep  itself  in  repair  and  replace  itself  when  worn  out. 
Under  other  conditions  a  capital  good  will  just  do  this; 
under  still  other  conditions  a  capital  good  will  add  to  the 
product  of  an  establishment  not  only  enough  for  its  own 
repair  and  replacement,  but  a  surplus  besides.  Experience 
has  taught  enterprisers  how  to  avoid  the  employment  of 
capital  goods  that  do  not  maintain  themselves,  and  of  those 
that  do  nothing  more  than  this.  Mistakes  are  of  course 
sometimes  made,  but  not  so  frequently  as  to  invalidate  the 
statement  that  capital  goods,  as  a  rule,  reproduce  them- 
selves economically  through  the  values  which  they  create. 
Intelligent  action  on  the  part  of  the  owner  of  such  goods  is 
essential  to  the  truth  of  this  proposition  ;  but  such  action 
may  generally  be  taken  for  granted. 

4.  W/iat  is  capital  to  the  individual  may  not  be  productive 
wealth  from  the  point  of  tiew  of  society. 

A  government  may  sell  its  bonds  in  order  to  raise  funds 
to  carry  on  a  profitless  war.  The  money  raised  is  spent 
on  powder  and  other  munitions  of  war,  which  are  soon 
destroyed.  The  wealth  furnished  by  the  purchasers  of  the 
bonds  has  simply  been  wasted,  and  cannot  contribute  to 
the  payment  of  interest  on  the  bonds  or  of  the  principal 
when  it  falls  due.  Interest  and  principal  are,  indeed,  paid, 
but  from  the  proceeds  of  taxation.  The  bondholder  re- 
gards his  bonds  as  capital ;  they  are  wealth  that  yields  an 
income,  as  he  views  the  matter.  But  we  can  easily  see 
that  it  is  not  the  bonds  that  produce  the  income ;  it  is  the 
labor  and  wealth  employed  in  production  that  do  this.  If 
all  the  bonds  were  destroyed,  the  aggregate  social  income 
would  be  not  in  the  least  reduced. 

Capital  of  this  kind  may  be  called  "  purely  acquisitive 
capital."     It  enables  its  holder  to  acquire  an  income  ;  it  does 


THE    PRODUCTIVITY   OF    CAPITAL  197 

not  produce  an  income.  Capital  which  actually  participates 
in  production  may  be  called  "  productive  capital."  The 
laws  which  we  shall  discuss  in  this  chapter  relate  only  to 
productive  capital. 

5.  Productive  capital  may  be  embodied  in  goods  t/iat  are 
the  product  of  industry,  or  in  goods  that  are  the  free  gift  of 
nature. 

A  generation  ago  practically  all  economists  restricted 
the  term  "capital"  to  productive  wealth  that  has  been  pro- 
duced by  industry,  such  as  machines,  stocks  of  materials, 
etc.  Productive  wealth,  the  origin  of  which  cannot  be 
traced  to  man's  industry,  was  usually  classified  under  the 
heading  "natural  agents,"  or  simply  under  "land,"  since 
land  is  by  far  the  most  important  good  in  this  class.  This 
terminology  is  still  widely  used  by  economists.  In  every- 
day language  men  speak  of  investing  capital  in  land,  as  of 
investing  capital  in  buildings  or  machinery.  This  usage 
will  be  followed  in  this  book ;  wherever  it  is  necessary  to 
distinguish  between  the  two  classes  of  productive  wealth, 
we  shall  call  the  one  artificial  capital,  the  other  natural 
capital. 

6.  Artificial  capital  originates  in  saving. 

It  may  at  first  appear  that  capital  comes  into  existence 
whenever  a  productive  instrument  is  created.  Reflection 
shows,  however,  that  this  cannot  be  true,  for  a  new  capi- 
tal good  often  merely  replaces  a  capital  good  worn  out  in 
the  process  of  production,  and  may  be  said  to  embody  the 
same  capital.  ,     . 

When  a  man  employs,  in  producing  a  tool  or  a  stock  of 
the  materials  of  production,  time  which  he  would  otherwise 
have  used  to  procure  for  himself  the  means  of  immediate 
enjoyment,  he  is  creating  capital.  These  capital  goods  are 
not  merely  replacing  capital  goods  previously  existing ; 
they  are  a  net  addition  to  the  stock  of  productive  wealth 
at  the  command  of  society,  which,  like  other  capital  goods, 


198  INTRODUCTION   TO    ECONOMICS 

will  for  the  future  maintain  themselves.  When  a  man 
uses,  to  employ  workmen  in  the  production  of  capital 
goods,  a  part  of  his  income  which  he  would  otherwise 
have  spent  for  consumer's  goods,  he  is  causing  new  capi- 
tal to  be  created ;  or,  we  may  say,  he  is  indirectly  creat- 
ing capital.  When  he  uses  part  of  his  income  to  buy 
capital  goods  that  are  already  in  existence,  he  is  creating 
new  capital  by  a  still  more  indirect  process.  Thus  if  a 
man  buys  a  threshing  machine  out  of  his  savings,  he 
places  in  the  hands  of  the  manufacturing  company  pur- 
chasing power  with  which  the  company  can  hire  men  to 
make  another  machine.  The  process  of  creating  new 
capital  may  take  a  yet  more  roundabout  course.  The  man 
who  saves  may  invest  his  savings  in  a  share  of  railway 
stock  —  which  is  nothing  more  than  an  evidence  of  owner- 
ship of  capital  goods  already  existing.  The  man  who  sells 
the  share  of  stock  may  use  the  proceeds  to  buy  a  share  in 
a  manufacturing  company.  Here  again  it  is  evident  that 
nothing  new  is  created.  The  seller  of  the  manufacturing 
stock  may,  however,  use  the  money  to  buy  a  share  in  a 
new  manufacturing  company,  and  this  company  may  em- 
ploy the  proceeds  to  hire  men  to  produce  new  capital 
goods  for  use  in  its  business.  Evidently  it  is  the  man 
who  saved  the  money  in  the  first  instance  who  is  the  true 
creator  of  the  capital  thus  added  to  the  stock  of  society. 

Under  present  conditions  the  process  of  creating  capi- 
tal is  usually  indirect.  One  man  saves  and  other  men 
produce  the  concrete  capital  goods  in  which  the  savings 
are  invested.  Of  course  it  sometimes  happens  that  such  a 
compHcated  process  fails  to  attain  its  proper  end.  One 
man  may  save  $100  and  buy  a  share  of  stock  from  another 
man,  who  uses  the  proceeds  to  meet  his  current  expenses. 
In  this  case  no  new  capital  is  created.  What  has  hap-, 
pened  is  that  a  part  of  the  existing  fund  of  capital  has 
changed  hands.     But  normally  men  avoid  trenching  upon 


THE    PRODUCTIVITY    OF    CAPITAL  199 

their  capital  ;  accordingly,  we  are   justified  in    regarding 
each  act  of  saving  as  the  creation  of  new  capital. 

Just  as  it  is  improper  to  regard  the  creation  of  a  capital 
good  as  in  itself  a  creation  of  capital,  so  it  is  improper  to 
regard  the  destruction  of  a  capital  good  through  ordinary 
use  as  the  destruction  of  capital.  For  during  its  lifetime 
a  capital  good  produces,  as  we  have  seen,  a  replacement 
fund.  After  the  capital  good  has  been  destroyed,  the 
capital  exists  under  another  form  —  as  money  or  as  other 
productive  goods. 

7.  Natural  capital  increases  with  tJie  development  of 
society. 

Until  the  frontiersmen  crossed  the  Appalachian  Moun- 
tains, the  land  of  the  Mississippi  Valley,  with  the  timber 
upon  it  and  the  coal  and  other  minerals  beneath  its  surface, 
was  scarcely  to  be  classed  as  wealth  at  all.  At  best,  it  was 
potential  wealth,  not  actual  wealth.  The  settlement  of  the 
country  and  the  development  of  means  of  communication 
transformed  this  potential  wealth  into  an  immense  fund  of 
productive  wealth,  or  capital.  Every  increase  in  popula- 
tion, every  improvement  in  methods  of  agricultural  produc- 
tion, increases  the  importance,  and  with  it  the  value,  of  the 
natural  resources  of  a  country.  Measuring  the  capital  rep- 
resented by  these  natural  resources  in  terms  of  value,  we 
see  that  it  is  constantly  growing  with  the  progress  of 
society.  The  introduction  of  durum  wheat  raised  the  capi- 
tal value  of  lands  in  part  of  the  arid  belt  from  practically 
nothing  to  $10  an  acre  or  more.  The  development  of  a 
spineless  cactus  may  transform  into  productive  wealth 
much  of  the  desert  land  of  the  Southwest.  New  processes 
of  steel  manufacture  have  endowed  iron  ore  deposits  origi- 
nally worth  very  little  with  the  character  of  highly  produc- 
tive capital. 

8.  The  productivity  of  a  capital  good  can  be  ascertained 
only  through  experimentation. 


200  INTRODUCTION   TO   ECONOMICS 

In  order  that  a  business  man  may  conduct  his  business 
successfully,  he  must  be  able  to  form  a  fairly  accurate  esti- 
mate of  the  productivity  of  each  class  of  capital  goods 
which  he  uses.  In  the  case  of  some  classes  of  capital 
goods  productivity  is  easily  determined.  Thus  if  one 
v^ishes  to  know  how  much  a  ton  of  fertilizer  will  produce, 
he  has  only  to  apply  it  to  one  of  two  equally  productive 
acres  of  ground.  The  difference  in  the  product  of  the  two 
acres,  less  the  cost  of  labor  employed  in  applying  the 
fertilizer,  is  a  fair  test  of  the  productivity  of  a  ton  of  ferti- 
lizer. We  may  term  this  the  gross  product  of  the  capital 
good.  After  deducting  from  this  product  a  sum  equal  to 
the  cost  of  the  fertilizer,  whatever  remains  is  the  net  prod- 
uct of  the  capital  good. 

Some  capital  goods,  however,  do  not  readily  admit  of 
any  such  process  of  e.xperimentation.  Thus  it  might  be 
difficult  to  determine  the  productivity  of  a  field,  apart  from 
that  of  the  seed,  fertilizer,  machinery,  and  labor  employed 
in  connection  with  it.  Of  course  one  acre  might  be  left 
untilled,  and  all  the  labor  and  auxiliary  capital  might  be 
employed  on  the  rest  of  the  field.  The  total  product 
would  be  less  than  it  would  have  been  had  all  the  field 
been  tilled  ;  and  this  diminution  in  product  would  indicate 
roughly  the  productivity  of  an  acre  of  ground.  This 
method  would  be  clumsy  and  expensive;  it  is,  moreover, 
unnecessary,  since  the  productivity  of  labor  and  of  auxiliary 
capital  employed  upon  the  land  may  be  determined,  for 
the  most  part,  by  the  method  already  illustrated.  Hence 
we  may  arrive  at  the  gross  product  of  the  field  by  subtract- 
ing from  the  total  product  of  the  farm  the  values  produced 
by  the  labor  and  the  auxiliary  capital.  By  subtracting  from 
the  gross  product  of  the  land  a  sum  of  value  sufficient  to 
replace  the  elements  of  fertility  destroyed  in  the  course  of 
the  year,  we  arrive  at  the  net  product  of  the  land. 

9.  The  net  product  of  capital  goods  is  commonly  known  as 
the  product  of  capital.  ' 


THE   PRODUCTIVITY   OF   CAPITAL  201 

Capital  goods  obviously  must  vary  widely  in  their  gross 
product.  Some  must  be  replaced  daily,  some  yearly,  some 
at  the  expiration  of  a  decade  or  more ;  a  few  classes,  like 
land,  are  practically  permanent.  Until  full  replacement  of 
goods  used  up  has  been  made,  a  fund  of  productive  wealth, 
or  capital,  cannot  be  said  to  be  productive.  A  manufac- 
turer who  finds  that  the  receipts  from  a  year's  business  are 
just  sufficient  to  maintain  intact  his  building,  machinery, 
stock  of  material,  and  fuel,  cannot  say  that  his  capital  has 
added  anything  to  his  income.  Capital  which  produces 
nothing  is  obviously  not  worth  having  ;  and  the  mere  fact 
that  men  make  sacrifices  to  possess  themselves  of  capital 
shows  that,  as  a  rule,  capital  may  be  expected  to  yield  an 
income. 

When  a  man  is  considering  whether  he  shall  invest  his 
capital  in  one  kind  of  capital  goods  or  in  another,  he  may 
usually  take  the  fact  of  self-replacement  of  goods  for 
granted.  .The  net  productivity  of  capital  goods,  or,  to  use 
a  simpler  term,  the  product  of  capital,  is  the  determining 
factor  in  his  calculations. 

10.  TJic  productivity  of  capital  invested  in  any  one  class 
of  goods  is  measured  by  tlie  addition  made  to  product  by  the 
last  or  marginal  unit  of  capital  thus  invested.  Other  things 
equal,  the  productivity  of  capital  in  any  one  form  shrinks 
with  increase  of  capital  in  that  form. 

Let  us  suppose  that  a  farmer  possesses  ten  fields,  vary- 
ing in  natural  fertility  from  a  very  high  degree  to  a  very 
low  degree.  And  let  us  assume  that  $1000  worth  of 
capital  in  the  form  of  machinery,  stock,  etc.,  or  auxiliary 
capital,  is  necessary  for  the  tillage  of  any  one  of  the  ten 
fields. 

If  the  farmer  has  control  over  only  $1000  worth  of 
auxiliary  capital,  he  will  of  course  place  it  upon  the  best 
field.  If  from  the  gross  product  of  that  field  he  deducts 
the  cost  of  labor  employed  in  connection  with  it,  together 


202  INTRODUCTION   TO    ECONOMICS 

with  a  sum  sufficient  to  cover  the  cost  of  upkeep  of  land 
and  stock,  he  arrives  at  the  net  product  of  his  agricultural 
capital  —  that  is,  of  capital  invested  in  both  fields  and 
stock.  How  much  is  due  to  the  bare  land,  how  much  to 
the  auxiliary  capital?  This  it  would  be  difficult  to  say,  as 
neither  would  have  produced  anything  without  the  other. 

Now  let  us  suppose  that  the  farmer  gets  possession  of 
another  $1000  to  invest  in  auxiliary  capital.  He  may  now 
till  the  field  which  is  least  inferior  to  the  first  one  cultivated. 
The  joint  product  of  this  field  and  of  the  $1000  of  capital 
will  be  less  than  that  of  the  first  field  because  of  the  differ- 
ence in  natural  fertility.  Shall  we  say  that  $1000  is  more 
productive  on  one  field  than  on  the  other?  The  two  units 
of  capital  are  just  alike ;  the  two  fields  are  unlike.  So  it 
would  seem  to  be  more  reasonable  to  assign  the  difference 
in  productivity  to  the  fields,  not  to  the  auxiliary  capital. 
And  this  is  what  a  practical  man  would  do.  If  the  first 
field  produces  $1000  and  the  second  $900,  he  would  say 
that  at  least  $100  of  the  product  of  the  first  is  the  product 
of  the  land,  apart  from  that  of  the  auxiliary  capital. 

Is  the  $900  produced  on  the  second  field  the  product  of 
the  auxiliary  capital  alone  ?  In  a  physical  sense,  certainly 
not ;  in  an  economic  sense  it  is.  This  sum  is  what  the  addi- 
tional $1000  worth  of  auxiliary  capital  adds  to  the  farmer's 
income ;  $900  is  what  he  would  lose  if  he  were  deprived 
of  either  of  his  two  units  of  capital. 

With  another  $1000  the  farmer  is  enabled  to  till  a  third 
field,  which  is  somewhat  less  fertile  than  the  second.  Per- 
haps this  field  produces  $800  net.  If  this  is  the  case,  the 
farmer  will  no  longer  regard  the  total  product  of  the  second 
field  as  the  product  of  the  auxiliary  capital  alone.  This 
auxiliary  capital  is  credited  with  no  larger  product  than 
that  of  auxiliary  capital  on  the  third  field  —  $800.  The 
other  $100  now  comes  to  be  considered  as  the  product  of 
the  land.     At  the  same  time,  of  course,  a  second  $100  is 


THE    PRODUCTIVITY    OF    CAPITAL 


203 


subtracted  from  the  product  of  auxiliary  capital  on  the  best 
grade  of  land.  And  as  the  farmer  adds  unit  after  unit  of 
auxiliary  capital  and  opens  field  after  field  to  tillage,  the 
productivity  of  auxiliary  capital  steadily  shrinks  and  that 
of  the  better  land  as  steadily  increases.  Perhaps  the  tenth 
field  yields  a  net  return  of  only  $100.  In  such  case  no 
one  of  the  ten  units  of  auxiliary  capital  can  be  said  to  yield 
more  than  this.  The  use  of  no  one  of  the  units  is  worth 
more  to  the  farmer  than  $100,  for  if  any  one  were  taken 
away  from  his  control,  he  would  replace  it  with  the  one 
employed  in  connection  with  the  poorest  field. 

In  a  grist  mill  the  amount  of  capital  which  may  be  in- 
vested in  machinery  varies  within  wide  limits.  Once  the 
mill  is  equipped  with  machinery,  it  would  be  difficult  to 
increase  greatly  the  amount  of  capital  invested  in  machin- 
ery, since  not  more  machines,  but  better  ones,  would  here 
be  the  result  of  increased  investment.  We  may,  however, 
suppose  that  in  determining  upon  the  kind  of  equipment 
to  be  employed,  an  enterpriser  goes  through  some  such 
calculation  as  the  following  :  — 

Given  a  building  and  a  certain  minimum  of  auxiliary 
capital  invested  in  machinery  —  say  $10,000,  an  annual 
return  of  $10,000  may  be  secured.  How  much  of  this  is 
the  product  of  the  building  .'*  how  much  is  the  product  of 
the  machinery.''  No  one  can  say;  neither  form  of  capital 
would  produce  anything  without  the  other.  Increase  the 
capital  in  machinery  by  another  $10,000  unit;  the  net 
return  increases,  we  will  say,  to  $15,000.  The  sum  added 
by  the  second  unit  of  auxiliary  capital  is  $5000;  as  the 
two  units  of  auxiliary  capital  are  interchangeable,  neither 
will  be  credited  with  more  than  this.  Thus  $5000  de- 
taches itself  from  the  joint  product  of  building  and  ma- 
chinery, and  is  credited  to  the  building.  Add  another 
$10,000  unit  in  the  form  of  machinery.  The  return  in- 
creases to  $17,000.     $2000,  then,  is  the  product  that  can 


204  INTRODUCTION  TO   ECONOMICS 

be  credited  to  this  unit  of  auxiliary  capital,  and  no  one  of 
the  three  units  will  be  credited  with  more  than  this.  The 
building  thus  comes  to  be  credited  with  $ii,ooo,  the  sum 
remaining  after  the  product  of  the  three  units  of  auxiliary 
capital  has  been  deducted. 

The  principle  involved  in  this  example  may  be  stated 
as  follows  :  The  productivity  of  any  unit  of  capital  em- 
bodied in  a  given  class  of  capital  goods  is  measured  by 
the  amount  added  to  the  aggregate  net  product  of  a 
business  by  that  unit  which  it  is  least  worth  while  to 
employ. 

11.  An  increase  in  the  capital  of  any  establishment,  at- 
tended by  no  parallel  increase  in  labor,  reduces  the  produc- 
tivity of  capital  and  increases  that  of  labor. 

Suppose  that  a  farmer  can  command  practically  an  in- 
definite amount  of  agricultural  capital,  whether  in  the 
form  of  land  or  in  the  form  of  movable  capital  goods,  but 
that  the  amount  of  labor  that  he  can  secure  is  limited  to 
ten  men.  With  $5000  invested  partly  in  land,  partly  in 
movable  capital  goods,  he  may  be  able  to  produce  $5000 
net.  We  should  here  find  difficulty  in  determining  what 
part  of  this  sum  is  produced  by  the  labor,  what  part  by 
the  capital.  An  additional  ^5000  of  capital  may  increase 
the  aggregate  product  of  the  business  by  54000.  This 
sum  we  should  properly  ascribe  to  the  new  capital.  And 
as  this  second  unit  of  capital  does  not  differ  in  any  essen- 
tial respect  from  the  unit  at  first  employed,  and  as  the 
removal  of  one  unit  of  the  two  would  have  the  same  effect 
as  the  removal  of  the  other,  we  may  properly  regard  them 
as  equally  productive.  The  extra  thousand  appearing  in 
connection  with  the  first  unit  must  then  be  credited  to  the 
other  factor  in  production  —  the  labor.  If  a  third  unit  of 
(^pital  increases  the  product  of  the  business  by  $3000, 
this  amount  will  measure  the  importance  of  any  one  of  the 
three  units  of  capital.     This  is  what  the  farmer  would  lose 


THE    PRODUCTIVITY   OF   CAPITAL  205 

if  he  were  deprived  of  the  use  of  any  of  the  units.  If  a 
fifth  unit  adds  only  $1000,  the  product  assignable  to  any 
unit  shrinks  to  that  figure.  And  of  course  with  each  re- 
duction in  the  product  assignable  to  capital,  the  product 
assignable  to  labor  increases. 

12.  If  the  capital  of  an  industry,  or  the  capital  of  all  soci- 
ety, increases,  the  productivity  of  capital  declines. 

Up  to  the  present  point  our  study  of  the  productivity  of 
capital  has  been  confined  to  the  single  business  establish- 
ment. We  must  now  consider  whether  similar  principles 
are  applicable  to  an  industry  in  its  entirety.  The  iron  and 
steel  industry  of  the  United  States  may  serve  as  our  type. 

The  capital  at  present  engaged  in  the  production  of  iron 
and  steel  may_be  placed  at  about  $1,000,000,000,  the  number 
of  men,  at  250,000.  Now  let  us  suppose  that  without  any 
revolutionary  change  in  the  demand  for  iron  and  steel  the 
capital  of  the  industry  is  increased  by  $100,000,000.  What 
will  be  the  effect  upon  the  productivity  of  capital  in  the 
industry  1 

It  is  fair  to  assume  that  before  the  increase  in  capital 
those  branches  of  the  industry  promising  the  highest  prof- 
its were  already  well  developed ;  that  the  richest  deposits 
of  ore  and  coking  coal  were  already  being  exploited  ;  that 
the  best  manufacturing  sites  had  been  selected.  To  what 
use,  then,  will  the  new  capital  be  put .''  Some  of  the  enter- 
prisers may  attempt  to  duplicate  existing  plant.  This  re- 
quires additional  labor,  and  such  labor  is  to  be  had  only 
by  inducing  new  men  to  enter  the  industry  or  by  enticing 
men  away  from  other  iron  manufacturers.  In  either  case  an 
advance  in  wages  will  follow,  which  will  soon  become  gen- 
eral throughout  the  industry.  In  the  old  estabHshments  as 
well  as  the  new  this  will  obviously  reduce  the  share  of  the 
aggregate  product  which  capital  will  receive.  Again,  the  in- 
crease in  iron  and  steel  products  thrown  upon  the  market 
will  lower  prices.     Thus,  while  the  wages  bill  of  an  estab- 


2o6  INTRODUCTION  TO   ECONOMICS 

lishment  per  unit  of  product  will  increase,  the  value  o! 
each  unit  of  product  will  diminish. 

If  all  the  new  capital  is  used  simply  to  duplicate  existing 
plant,  wages  will  rise  to  a  decidedly  higher  level.  The  in- 
dustry will  need  one  tenth  more  men  than  it  has  at  present, 
and  these  will  be  slow  to  appear  unless  they  are  offered 
high  wages.  The  fall  in  prices,  moreover,  will  be  a  serious 
one,  as  the  output  will  be  increased  about  ten  per  cent. 
But  when  the  prices  of  the  staple  products  of  an  industry 
fall,  it  often  pays  to  develop  new  branches  of  the  industry 
that  under  earlier  conditions  were  not  profitable.  When 
wages  rise,  it  pays  to  introduce  machinery  that  saves  labor. 
Part  of  the  new  capital  will  be  absorbed  in  these  ways,  and 
thus  the  productivity  of  capital  will  be  prevented  from 
sinking  to  as  low  a  level  as  would  otherwise  be  the  case. 
The  fact  remains  that  the  capital  will  be  less  productive 
after  the  increase  than  before  it;  wages  will  be  higher 
and  prices  lower.  The  increase  in  the  aggregate  capital 
of  the  industry,  other  things  equal,  will  reduce  the  produc- 
tivity of  each  unit. 

The  same  principle  is  still  more  clearly  applicable  to  in- 
dustrial society  as  a  whole.  The  iron  and  steel  industry 
can  relieve  the  pressure  upon  its  labor  supply  by  inducing 
men  to  leave  other  industries.  If  the  capital  of  society  as 
a  whole  increases,  a  pressure  is  placed  upon  the  labor  sup- 
ply, for  which  there  is  no  ready  means  of  relief.  The  exist- 
ing capital  is  normally  sufficient  to  provide  every  one  who 
desires  to  work  with  the  necessary  appliances.  If,  then, 
the  capital  of  all  industries  increases  more  rapidly  than 
the  population,  the  average  capital  employed  with  each 
laborer  must  increase.  Such  increase  in  capital  must  be 
embodied  in  improvements  upon  existing  appliances,  and, 
owing  to  the  operation  of  the  law  of  diminishing  returns, 
will  increase  the  product  of  industry  less  than  an  equal 
amount  of  capital  does  when  the  social  fund  is  smaller. 


THE    PRODUCTIVITY   OF    CAPITAL  207 

13.  The  opening  of  new  opportunities  for  investment  may 
counteract  the  effect  of  increase  in  capital. 

There  are  of  course  conditions  under  which  an  increase 
in  capital  may  not  be  followed  by  a  reduction  in  the  prod- 
uctivity of  capital.  If,  for  example,  the  labor  supply  in- 
creases as  rapidly  as  the  supply  of  capital,  there  is  no 
reason  why  the  productivity  of  capital  should  decline. 
Again,  suppose  that  some  jiractical  method  of  draining 
extensive  swampy  regions  or  of  irrigating  vast  tracts  of 
arid  land  were  discovered.  The  new  capital  might  be 
absorbed  by  the  opening  of  these  fields.  In  the  last 
century,  though  capital  has  increased  enormously,  there 
has  been  a  corresponding  enlargement  of  the  field  of  in- 
vestment ;  accordingly,  the  productivity  of  capital  has  de- 
clined little,  if  at  all. 

14.  An  increase  in  artificial  capital,  while  reducing 
returns  on  that  form  of  capital,  is  likely  to  iiwrease  the 
returns  fro7n  natural  capital. 

It  has  already  been  indicated  that  by  placing  more  and 
more  auxiliary  capital  upon  a  given  area  of  land  one  must 
ordinarily  reduce  the  productivity  of  auxiliary  capital  and 
increase  the  productivity  of  land.  It  will  naturally  be  the 
aim  of  the  business  man  to  keep  his  capital  uniformly  pro- 
ductive ;  if  he  has  too  much  auxiliary  capital  he  will  en- 
deavor to  get  more  land,  and  vice  versa.  He  will  ask 
himself:  Would  it  pay  me  better  to  invest  my  next  $1000 
in  land  or  in  auxiliary  capital .''  And  he  will  continue  to 
direct  his  investments  toward  whichever  class  of  capital 
goods  is  for  the  moment  the  more  productive,  until  the 
superiority  of  that  class  disappears. 

Similarly,  an  entire  industry  may  expand  with  more  or 
less  symmetry,  distributing  its  new  capital  among  the 
various  classes  of  capital  goods  of  which  it  stands  in  need. 
If  the  beet  sugar  industry  expands,  not  only  are  more 
factories  constructed,  more  machinery  for  the  cultivation 


2o8  INTRODUCTION   TO   ECONOMICS 

of  beets  purchased,  but  more  land  is  drawn  into  the  service 
of  the  industry.  This  land  is,  of  course,  taken  away  from 
other  industries  —  wheat  culture,  dairying,  etc. 

When  the  social  fund  of  capital  increases,  on  the  other 
hand,  it  is  not  possible  for  a  symmetrical  increase  in  all 
classes  of  capital  to  take  place.  The  land,  we  may  siip- 
pose,  is  already  almost  all  in  use  ;  the  best  mines  are 
opened  ;  the  most  available  courses  for  railways  and  canals 
are  already  occupied.  These  things  the  new  capital  can- 
not duplicate ;  their  importance,  therefore,  steadily  increases. 
On  the  other  hand,  steel  rails,  locomotives,  factory  build- 
ings and  thousands  of  other  forms  of  capital  goods  are 
readily  duplicated.  The  marginal  productivity  of  capital 
in  these  forms  naturally  declines,  and  a  larger  part  of  the 
product  is  left  to  be  divided  between  labor  and  natural 
capital. 

15.  IV/ic'u  tJic  return  to  natural  capital  varies  from  the 
return  to  artificial  capital,  equalisation  is  commonly  brought 
about  by  revalnatioji. 

When,  however,  we  speak  of  the  productivity  of  capital 
in  general  we  usually  take  as  our  test  the  productivity  of 
new  capital  — ■  and  this,  we  see,  is  practically  the  capital  in 
goods  which  are  capable  of  duplication.  And  instead  of 
thinking  of  the  old  capital  in  nondupHcable  goods  as  more 
than  normally  productive,  we  are  likely  to  revalue  the 
capital  in  such  forms.  Ten  years  ago,  let  us  say,  a  five- 
acre  lot  gave  as  large  a  net  product  as  a  threshing  machine. 
To-day  the  same  piece  of  land  yields  twice  as  large  a  net 
return  as  a  threshing  machine  equal  in  value  to  the  one  of 
ten  years  ago.  We  might  say  that  the  capital  in  land  has 
doubled  in  productivity.  But  it  is  more  usual  to  say  that 
to-day  the  land  represents  twice  as  much  capital  as  the 
threshing  machine,  although  it  represented  no  more  capital 
than  the  threshing  machine  ten  years  ago.  By  a  similar 
process  of  revaluation,  the  productivity  of  all  capital  which 


THE   PRODUCTIVITY   OF   CAPITAL  209 

is  abnormally  productive  is  reduced  to  the  general  level. 
This  process  of  revaluation  will  receive  our  further  atten- 
tion in  the  next  chapter. 

16.  ■  The  productivity  of  artificial  capital  varies  at  any 
particular  time  from  industry  to  industry,  but  tends  con- 
stantly tozvard  a  uniform  level. 

Even  capital  which  is  embodied  in  capital  goods  that 
are  capable  of  reduplication  may  at  any  given  time  vary 
widely  in  productivity  from  establishment  to  estabhshment, 
or  from  industry  to  industry.  It  is  only  by  experimentation 
that  the  actual  productivity  of  capital  can  be  determined, 
and  owing  to  the  changing  character  of  modern  industry 
the  process  of  experimentation  must  go  on  without  ceasing. 
Accordingly,  there  are  always  chances  of  mistakes  in  invest- 
ments. A  cotton  manufacturer  may  overestimate  the  prod- 
uctivity of  capital  in  a  given  type  of  loom;  after  purchasing 
and  installing  the  machine  he  must  content  himself  with 
what  it  will  produce,  even  though  he  knows  that  the  same 
amount  of  capital  would  in  another  form  yield  a  far  higher 
return.  Cotton  manufacturers  as  a  class  may  overestimate 
the  future  demand  for  cotton  goods,  and  so  may  be  led  to 
invest  heavily  in  buildings  and  machinery  which  prove  in- 
capable of  returning  the  normal  rate  of  interest  on  capital. 
At  the  same  time  the  shoe  industry  may  be  undersupplied 
with  capital ;  for  a  time,  at  least,  every  one  hundred  dollars 
invested  in  the  industry  may  yield  an  abnormally  high 
return. 

Such  disparity  in  the  productivity  of  capital  in  the  two 
industries  would,  however,  tend  to  disappear.  The  capital 
invested  in  new  cotton  mills  would,  of  course,  be  fixed  in  the 
industry  for  a  long  period  of  time.  But  in  the  industry  as 
a  whole  there  are  always  some  mills  that  are  about  to  be  dis- 
mantled, having  reached  the  Hmit  of  their  useful  existence. 
These  mills  have  presumably  earned  in  the  past  a  sum  suffi- 
cient to  replace  themselves  with  new  mills  of  a  value  equal 


2IO  INTRODUCTION   TO   ECONOMICS 

to  that  of  the  original  ones.  If  the  cotton  industry  is  suf- 
fering from  a  depression  while  the  shoe  industry  is  highly 
prosperous,  the  replacement  fund  will  be  diverted  to  the 
latter  industry.  Through  the  reduction  of  capital  in  the 
cotton  industry  the  productivity  of  capital  in  that  field  is 
increased  ;  through  the  increase  of  capital  in  the  shoe  indus- 
try the  productivity  of  capital  is  reduced  in  that  industry. 
It  is  easy  to  see  that  if  this  process  continues  for  any 
length  of  time  the  original  disparity  in  productivity  must 
disappear. 

The  equalization  of  productivity  is  hastened  by  the  dis- 
position of  new  accumulations  of  capital.  The  fund  of 
capital,  under  modern  conditions,  is  constantly  growing  in 
magnitude ;  consequently  industries  are,  as  a  rule,  expand- 
ing. The  new  capital  naturally  seeks  the  most  productive 
fields.  If,  therefore,  the  rate  of  return  in  the  cotto-n  indus- 
try is  abnormally  low  while  that  in  the  shoe  industry  is 
abnormally  high,  the  new  capital  will  avoid  the  former 
industry  and  seek  investment  in  the  latter.  The  influx  of 
new  capital  into  the  shoe  industry  reduces  productivity 
there,  until  at  last  capital  is  no  more  productive  in  the  one 
industry  than  in  the  other.  When  this  point  has  been 
reached,  further  additions  to  the  supply  of  capital  are 
divided  impartially  between  the  two  industries,  reducing 
productivity  uniformly. 

It  is,  of  course,  possible  that  the  productivity  of  capital 
in  the  two  industries  may  never  be  absolutely  equal. 
While  the  tide  of  new  capital  is  setting  steadily  toward 
the  shoe  industry,  a  new  demand  for  cotton  goods  or  a 
new  method  of  manufacture  may  appear  and  raise  the 
productivity  of  capital  in  the  cotton  industry  above  that  of 
the  shoe  industry.  Some  time  will  elapse  before  the 
change  in  the  relative  positions  of  the  two  industries  is 
generally  known  ;  in  the  meantime  the  flow  of  new  capi- 
tal into  the  shoe  industry  continues.     Eventually  the  new 


THE   PRODUCTIVITY   OF   CAPITAL  211 

capital  is  diverted  to  the  cotton  industry  ;  it  may  continue 
to  flow  in  that  direction  after  the  cotton  industry  has  lost 
its  relative  superiority.  We  can  only  say  that  a  tendency 
toward  equalization  of  productivity  existe ;  not  that  equali- 
zation is  ever  exactly  realized. 

17.  Any  barrier  preventing  tJi:  free  floio  of  capital  into 
an  industry  makes  possible  an  ab^iorinally  Jiigh  return  on 
capital  in  that  ijidnstry. 

It  is,  of  course,  to  be  remembered  that  the  productivity 
of  capital  is  not  the  only  thing  that  an  investor  takes  into 
account  in  deciding  in  what  industry  he  shall  invest  his 
savings.  In  some  investments  the  danger  of  losing  all  or 
a  part  of  the  capital  invested  is  great.  Capital  employed 
in  developing  the  asphalt  deposits  of  Venezuela  may  be 
highly  productive  ;  but  there  is  a  chance  that  the  existing 
government  of  Venezuela,  from  which  title  to  the  asphalt 
deposits  is  derived,  may  be  overturned,  and  a  new  govern- 
ment may  confiscate  the  capital  invested  in  the  business. 
Capital  invested  in  street  railways  may  be  very  productive. 
But  if  cities  do  not  follow  a  consistent  policy  in  chartering 
new  companies,  it  is  possible  that  at  any  time  rival  lines 
may  be  estabhshed  on  parallel  streets  and,  if  unable  to 
make  large  returns  themselves,  they  may,  nevertheless, 
reduce  the  return  on  capital  invested  in  the  original  lines 
to  almost  nothing.  The  capital  still  remains  in  the  pos- 
session of  the  investor,  but  it  is  "dead  capital."  A  mer- 
chant's capital,  invested  in  a  fancy  fabric,  may  promise 
high  returns;  but  a  sudden  change  in  fashion  may  force 
the  merchant  to  sell  the  goods  at  a  price  which  not  only 
yields  no  return  on  the  capital  invested,  but  which  entails 
an  actual  impairment  of  the  capital  fund  itself. 

Some  risk,  it  is  plain,  inheres  in  every  business ;  in 
some  fields  of  investment,  however,  the  risk  is  so  small  as 
to  be  negligible,  while  in  other  fields  no  prudent  investor 
can  disregard  it.     Other  things  equal,  the  vast  majority  of 


212  INTRODUCTION   TO   ECONOMICS 

investors  will  prefer  to  invest  in  the  safer  fields.  A  dis« 
proportionately  large  share  of  the  capital  of  society,  there- 
fore, seeks  the  safer  investments,  and  as  a  result  the 
productivity  of  capital  in  such  investments  falls  below  the 
rate  of  return  to  capital  in  the  more  hazardous  investments. 
And  thus  it  is  that  there  appears  a  regular  variation  in  the 
productivity  of  capital  corresponding  with  variations  in 
risk. 

It  is,  of  course,  clear  that  it  is  not  actual  risk,  but  esti- 
mated risk,  that  affects  the  distribution  and  hence  the  prod- 
uctivity of  capital.  It  is  quite  possible  that  the  risk  of  los- 
ing capital  invested  in  banking  in  Texas  is  less  than  the  risk 
of  losing  capital  similarly  invested  in  New  York.  But  if 
most  of  the  persons  having  capital  to  invest  mistakenly 
believe  that  the  reverse  is  true,  a  disproportionately  large 
part  of  the  flow  of  new  capital  will  enter  the  New  York  in- 
vestment field  and  reduce  the  productivity  of  capital  there 
below  the  level  prevailing  in  Texas. 

In  an  earlier  chapter  we  saw  that  risk  affects  wages 
only  in  so  far  as  it  affects  the  distribution  of  labor ;  further, 
that  if  enough  reckless  workmen  can  be  found  to  man  the 
dangerous  trades,  risk  will  not  affect  \vages  at  all.  Exactly 
the  same  thing  is  true  of  capital.  If  there  were  enough 
investors  who  always  chose  the  more  remunerative  employ- 
ments for  capital,  regardless  of  risk,  the  hazardous  fields 
would  soon  be  so  well  supplied  with  capital  that  they  would 
yield  no  higher  returns  than  the  safer  ones.  As  a  rule,  how- 
ever, capital  is  far  more  timid  in  assuming  risks  than  labor. 
It  is  therefore  more  anomalous  to  find  capital  in  a  haz- 
ardous field  yielding  only  normal  returns  than  it  is  to 
find  workmen  in  dangerous  occupations  receiving  only 
normal  wages. 

Risk,  then,  may  be  regarded  as  a  barrier  which  pre- 
vents capital  from  flowing  freely  into  some  of  the  more 
productive  fields.     It  is  of  course  not  the  only  natural  bar- 


THE    PRODUCTIVITY   OF    CAPITAL  213 

rier  affecting  the  flow  of  capital.  If  a  particular  industry  is 
subject  to  the  universal  moral  disapproval  of  a  community, 
most  capitalists  will  refuse  to  invest  in  it.  Those  who  are 
unscrupulous  enough  to  do  so  may  enjoy  the  high  returns 
that  flow  from  an  industry  that  is  under-supplied  with  capi- 
tal. Thus,  high  returns  are  often  obtained  from  capital 
invested  in  gambling  dens  and  opium  "joints."  It  is,  of 
course,  possible  that  the  investment  institutions  of  a  country 
may  be  of  such  a  nature  that  a  man  can  hold  stock  in  dis- 
reputable enterprises  without  the  knowledge  of  his  associ- 
ates, and  that  investors  who  have  no  personal  scruples  are 
numerous.  Under  these  conditions  the  productivity  of  capi- 
tal in  such  ventures  will  eventually  fall  to  the  normal  level. 

18.    Smnniary. 

Material  goods  which  serve  as  means  of  production  are 
known  as  capital  goods.  In  the  normal  course  of  industry, 
each  capital  good,  before  it  is  worn  out,  makes  at  least  a 
sufficient  addition  to  product  to  replace  itself  with  an  equally 
valuable  capital  good ;  and  under  normal  conditions,  each 
capital  good,  when  worn  out,  is  actually  replaced.  Capital 
goods  may  therefore  be  regarded  as  a  self-perpetuating 
fund  of  productive  wealth.  This  fund  is  termed  productive 
capital ;  it  is  to  be  distinguished  from  those  forms  of  wealth, 
also  commonly  termed  capital,  which  add  nothing  to  the 
product  of  society,  although  they  enable  their  owners  to 
secure  an  income.  Under  certain  conditions,  it  is  necessary 
to  distinguish  between  that  productive  capital  which  is  the 
product  of  industry  and  that  which  is  the  free  gift  of  na- 
ture. The  former  may  be  ternied  artificial,  the  latter 
natural,  capital. 

The  productivity  of  each  capital  good  can  be  ascer- 
tained only  through  experimentation.  A  distinction  must 
be  made  between  the  gross  product  of  a  capital  good  —  the 
total  value  product  originating  in  it  —  and  its  net  product 
—  the  sum  of  value  remaining  after  deduction  of  the  ex- 


214  INTRODUCTION   TO   ECONOMICS 

pense  of  repairs  or  replacement.  The  net  product  of  capi- 
tal goods  may  be  regarded  as  the  product  of  the  fund  of 
such  goods,  or  capital. 

The  productivity  of  capital  invested  in  any  class  of  goods 
is  determined  by  the  addition  to  net  product  made  by  those 
goods  of  the  class  that  perform  the  least  important  func- 
tions. Every  increase  in  the  amount  of  capital  invested  in 
a  given  class  of  goods  tends  to  reduce  the  productivity  of 
each  unit  of  capital  in  that  class,  and  to  raise  the  produc- 
tivity of  capital  invested  in  other  classes  of  goods,  as  well 
as  the  productivity  of  labor.  Natural  capital  often  fails  to 
increase  as  rapidly  as  artificial  capital;  consequently,  for 
long  periods  of  time  the  productivity  of  natural  capital 
goods  tends  to  increase,  while  that  of  artificial  capital  goods 
tends  to  decline.  Equalization  of  returns  to  the  two  classes 
of  capital  can  be  brought  about  only  through  revaluation 
of  the  natural  capital  goods.  The  earnings  of  capital  in 
the  different  classes  of  artificial  capital  goods  tend,  under 
competition,  toward  a  uniform  level;  in  many  cases,  how- 
ever, barriers  preventing  the  free  flow  of  capital  keep  the 
earnings  of  capital  in  one  field  permanently  higher  than 
in  another. 


CHAPTER   XIII 

RENT,   INTEREST,    AND    CAPITALIZATION 

1.  Rent,  in  everyday  speech,  is  a  payment  for  the  tempo- 
rary use  of  durable  goods. 

In  popular  usage  the  term  "  rent "  is  applied  to  any  pay- 
ment which  one  person  makes  to  another  for  the  tem- 
porary use  of  a  concrete  good  or  group  of  goods.  Thus 
rent  may  be  paid  for  the  use  of  a  farm,  a  house,  a  piano,  a 
square  yard  of  advertising  space  on  a  bill  board.  In  the 
nature  of  the  case,  only  those  things  can  be  rented  which 
remain  practically  intact  through  the  period  of  use.  One 
never  rents  a  bin  of  coal  or  a  stock  of  merchandise.  Nor 
does  one  ever  rent  goods  which  can  serve  their  purpose 
only  by  entering  into  permanent  combination  with  other 
goods.  No  one  would  think  of  trying  to  rent  steel  beams 
to  be  used  in  the  construction  of  his  house.  The  more 
nearly  indestructible  a  good  is,  and  the  more  perfectly  it 
yields  up  its  services  without  losing  its  identity,  the  better 
is  it  adapted  to  the  renting  contract.  Thus  a  field,  being 
practically  indestructible,  may  very  well  be  rented  for  a 
period  of  years,  although  if  its  cultivation  requires  the  in- 
corporation of  a  large  amount  of  auxiliary  capital  in  the 
soil,  in  the  form  of  drains  or  irrigation  ditches,  the  field  and 
the  auxiliary  capital  must  usually  be  rented  together.  A 
piano,  which  is  much  more  likely  to  be  injured,  neverthe- 
less lends  itself  fairly  well  to  the  renting  contract  because 
no  other  capital  good  enters  into  permanent  combination 
with  it  in  use. 

2.  The  term  rent  has  been  eommonly  used  by  economists  to 
designate  income  arising  from  natural  agents. 

In  the  cTassical  economic  terminology,  rent  included  all 
income   from    permanent   natural    agents,  whether   these 

215 


2i6  INTRODUCTION  TO   ECONOMICS 

agents  were  leased  or  employed  in  production  by  theii 
owners.  A  field,  a  building  site,  or  a  waterfall,  it  was  said, 
yields  rent.  Incomes  from  houses,  machines,  and  other 
reproducible  goods  were  called  interest  on  capital.  The 
word  rent  is  used  in  the  classical  sense  by  a  large  number 
of  our  living  economists.  While  the  term  will  be  given  a 
different  meaning  in  this  book,  we  shall  recognize  rent  in 
the  traditional  sense  under  the  name  ground  rent. 

3.  The  term  rent  in  its  broadest  sense  includes  the  prod- 
ucts of  all  capital  goods,  xvhether  rented  by  the  enterpriser 
or  owned  by  him. 

If  a  man  owns  and  manages  a  farm  which  he  could  let  at 
a  rental  of  $1000,  we  may  say  that  $1000  out  of  his  income 
is  really  the  rent  of  his  farm.  True,  he  does  not  pay  this 
sum  to  any  one  ;  but  neither  does  he  pay  any  one  wages  for 
the  labor  which  he  himself  performs.  It  would  be  absurd, 
however,  to  say  that  a  man  earns  no  wages  when  he  is  work- 
ing for  himself.  As  employer  he  pays  himself  wages  as 
workman.  In  like  manner,  the  man  who  cultivates  his  own 
field  may  be  thought  of  as  paying  rent,  as  cultivator,  to  him- 
self, as  landlord.  So,  if  an  ocean  transportation  company 
owns  and  sails  a  ship  which  it  could  let  for  $5000  a  year,  we 
may  regard  $5000  out  of  the  proceeds  of  the  company's 
business  as  the  rent  of  this  particular  ship.  In  this  broad 
sense  of  the  term,  rent  may  be  defined  as  that  part  of  the 
proceeds  of  a  business  which  is  economically  due  to  a  par- 
ticular capital  good.  It  is  the  economic  product  of  a  capi- 
tal good,  regarded  as  a  lump  sum.  And  as  even  the  most 
perishable  of  capital  goods  yield  a  product  which  may  be 
measured  in  this  way,  we  may  strain  the  ordinary  meaning 
of  the  term  rent  so  as  to  include  the  concrete  products  of 
all  capital  goods  whatsoever. 

4.  For  practical  reasons,  a  study  of  rent  may  best  be  con- 
fined to  the  products  of  goods  that  have  a  high  degree  of 
permanence. 


RENT,   INTEREST,   AND   CAPITALIZATION         217 

While  the  term  rent  is,  as  has  been  said,  properly  ap- 
plied to  the  product  of  any  concrete  capital  good,  we  shall 
in  this  chapter  confine  our  study  to  the  rent  of  those  classes 
of  goods  that  are  of  such  a  nature  as  to  permit  the  trans- 
fer of  their  uses  under  renting  contracts.  The  distinguish- 
ing characteristic  of  this  class  of  goods  is  that  the  capital 
embodied  in  them  is  fixed  there,  for  a  considerable  period  of 
time  at  least.  It  takes  perhaps  ten  years  before  the  capi- 
tal invested  in  a  boat  can  migrate  to  some  industry  upon 
the  dry  land.  The  capital  embodied  in  a  well-built  house 
may  be  fixed  there  for  fifty  years  ;  and  the  capital  invested 
in  a  field,  in  a  tunnel,  or  in  an  excavation  must  remain  where 
it  is  forever.  It  is  true  that  you  may  take  your  capital  out 
of  a  field ;  this  you  do  when  you  sell  it.  But  what  you 
really  do  when  you  sell  the  field  is  to  transfer  to  another 
person  your  claim  to  the  capital  it  represents.  The  capital 
in  the  field  is  the  same  after  the  transaction  as  it  was  before 
it.  Such  permanently  invested  capital  may  be  contrasted 
with  the  capital  invested  in  transitory  forms,  as  coal,  raw 
materials,  merchants'  stocks.  The  capital  invested  in  these 
forms  returns  to  its  owner  in  a  relatively  short  time  in  the 
form  of  purchasing  power,  and  may  be  reinvested  in  any 
one  out  of  a  thousand  different  classes  of  capital  goods. 
The  return  to  such  transitory  goods  is  most  conveniently 
calculated  as  a  percentage  return  to  the  capital  invested  in 
them.  It  is  natural  to  think  of  the  return  to  a  farm  or  a 
building  as  a  certain  sum  of  money,  or  a  rent.  One  may,  of 
course,  translate  the  rent  into  terms  of  interest  on  the  capi- 
tal invested  in  the  farm  or  building.  On  the  other  hand, 
it  is  natural  to  think  of  the  return  to  a  merchant's  stock  in 
trade  as  interest  on  the  capital  invested  in  the  stock,  al- 
though it  would  be  quite  possible  to  arrive  at  the  returns  to 
the  stock  by  adding  together  the  net  products  of  all  the 
capital  goods  whose  services  have  been  used. 

5.    Gross  rent  is  the  total  product  of  a  capital  good ;  net 


2i8  INTRODUCTION   TO   ECONOMICS 

rent  is  whatever  remains  of  the  product  after  deductions  have 
been  made  for  the  repair  and  replacement  of  the  capital 
good.     Net  rent  is  identical  ivitJi  interest. 

We  must  be  careful  to  distinguish  between  the  total  prod- 
uct of  a  capital  good,  or  its  gross  rent,  and  that  part  of 
the  product  remaining  after  the  cost  of  depreciation  of  the 
capital  good  has  been  deducted,  or  net  rent.  To  arrive  at 
the  net  rent  of  a  house  we  must  deduct  from  the  gross  rent 
a  sum  sufficient  to  meet  the  cost  of  repairs,  together  with  a 
year's  proper  contribution  to  a  fund  for  the  replacement  of 
the  house  when  it  shall  cease  to  be  habitable.  Even  the 
payment  for  the  use  of  a  field  is  a  gross  rent.  The  field 
wears  out  —  that  is,  it  loses  through  cropping  a  part  of  its 
original  or  acquired  fertility.  The  owner  of  the  field  must, 
therefore,  set  aside  a  part  of  the  product  of  the  land  to  re- 
store the  fertility  ot  the  soil. 

It  will  be  noted  that  net  rent,  in  the  sense  in  which  the 
term  is  used  here,  is  nothing  but  interest  under  another 
form.  We  will  say  that  a  house  yields  a  net  rent  of  $1000. 
This  $1000  is  the  sum  of  interest  on  the  capital  invested  in 
the  house.  If  this  capital  is  $10,000,  each  $100  of  it  yields 
an  income  of  $\o.  In  other  words,  the  rate  of  interest  is 
ten  per  cent.  In  general,  if  we  reduce  the  rent  of  a  group 
of  capital  goods  to  a  percentage  of  the  capital  embodied  in 
them,  what  we  have  is  interest  on  this  capital. 

6.  TJie  rent  of  tJie  permaneiit  goods  nsed  in  an  enterprise 
is  most  conveniently  treated  as  a  residue  remaining  after  the 
wages  of  labor,  charges  for  the  use  of  capital  in  perishable 
forms,  and  the  cost  of  materials  and  other  perishable 
goods  have  been  deducted  from  the  total  product  of  the 
enterprise. 

In  the  last  chapter  we  saw  that  there  are  two  ways  of 
arriving  at  the  product  of  a  concrete  capital  good,  or  its 
rent.  One  way  is  to  withdraw  the  capital  good  from  the 
productive  combination  into  which  it    enters,   noting    the 


RENT,   INTEREST,   AND   CAPITALIZATION  2ig 

shrinkage  in  product  that  follows.  The  other  way  is  to 
deduct  from  the  gross  receipts  from  a  group  of  several 
goods  the  shares  (if  these  can  be  independently  ascertained) 
that  are  due  to  all  of  the  goods  except  one.  What  is  left 
is  of  course  the  product  or  rent  of  the  remaining  good. 
Either  method  may  be  employed  in  ascertaining  the  rent 
of  many  capital  goods ;  but  the  latter  method  is  most  fre- 
quently employed  in  the  case  of  goods  that  lend  themselves 
readily  to  the  renting  contract.  If  one  wishes  to  rent  a 
steam  thresher,  for  example,  he  will  first  of  all  inquire  what 
the  gross  earnings  from  the  operation  of  the  machine  are 
likely  to  be.  Perhaps  such  earnings  will  average  $20  a  day. 
In  order  to  operate  the  thresher,  it  is,  of  course,  necessary 
to  employ  labor  and  auxiliary  capital  goods  —  as  coal  and 
machine  oil  —  in  connection  with  it.  The  labor  must  be 
paid  for  at  the  prevailing  rate  of  wages  ;  coal  and  oil  must 
be  paid  for  at  the  market  price.  There  are  accordingly  defi- 
nite sums  that  must  be  deducted  from  the  gross  receipts 
from  the  operation  of  the  machine.  Whatever  is  left  after, 
these  charges  have  been  met — possibly  $10  —  is  the  gross 
rent  of  the  machine  for  the  day. 

In  the  foregoing  example  the  cost  of  labor,  of  coal,  and  of 
oil  were  regarded  as  preferred  charges  upon  the  earnings 
of  the  enterprise,  and  this  mdeed  they  are.  The  operator 
of  the  threshing  machine  must  pay  at  least  the  prevailing 
rate  of  wages,  or  he  cannot  get  labor  to  run  the  machine. 
Similarly,  he  must  pay  the  market  price  of  coal.  Labor 
and  coal  have  a  multitude  of  uses  outside  of  the  business 
of  threshing ;  if  not  properly  rewarded  in  that  busi- 
ness they  go  elsewhere.  The  machine,  on  the  other  hand, 
cannot  seek  other  employment.  It  is  committed  to  a  par- 
ticular function  ;  consequently  it  cannot  enforce  any  claim 
for  a  specific  remuneration.  The  machine  is,  as  it  were,  a 
residuary  claimant;  and  this  is  more  or  less  true  of  most 
of  the  capital  goods  that  are  actually  rented.     Economists 


2  20  INTRODUCTION   TO    ECONOMICS 

therefore  find  it  convenient  to  treat  rent  as  though  it  were 
always  determined  in  this  way. 

A  steamship  building  company,  not  having  sufficient 
orders  on  hand,  launches  a  freighter  on  its  own  account, 
trusting  to  the  chance  that  some  ocean  transportation  com- 
pany will  be  ready  to  pay  a  fair  rental  for  its  use.  What 
will  determine  the  rent  that  the  transportation  company 
will  offer  to  pay?  The  managers  of  that  company  can 
probably  estimate  pretty  accurately  what  the  gross  receipts 
from  a  year's  operation  of  such  a  ship  would  be.  Let  us 
say  that  the  estimated  gross  receipts  are  $35,000.  From 
this  sum  must  be  deducted  the  wages  of  officers  and  men, 
$7000;  charges  for  pilotage,  harbor  dues,  etc.,  $1000; 
the  cost  of  coal  and  provisions,  $10,000;  miscellaneous 
expenses,  $1000.  Nor  is  this  quite  all.  The  $10,000  in- 
vested in  coal  and  provisions  —  supposing  that  the  trans- 
portation company  must  purchase  the  whole  amount  at 
the  beginning  of  the  year — is  capital  that  would  in  any 
other  field  earn  $500  interest.  This  sum  must  therefore 
be  added  to  the  preferred  charges  of  operating  the  ship. 
The  $15,500  remaining  out  of  the  estimated  gross  receipts 
is  the  maximum  rent  that  the  transportation  company  can 
pay  for  the  use  of  the  ship.  This  sum,  the  gross  rent  of 
the  ship,  includes,  however,  payment  for  the  depreciation 
of  the  ship  through  one  year's  use.  If  this  amounts  to 
$10,000,  we  have  remaining  the  sum  of  $5500  as  the  net 
rent. 

Similarly,  the  gross  rent  of  a  farm  is  found  by  deducting 
from  gross  receipts  a  sum  that  is  sufficient  to  pay  the  wages 
of  all  labor  employed  in  cultivating  it;  to  replace  all  capi- 
tal goods  used  up ;  to  keep  up  the  efficiency  of  all  stock 
and  machinery,  together  with  interest  at  the  prevailing  rate 
on  the  capital  invested  in  such  movable  capital  goods. 
To  arrive  at  the  net  rent  we  must  deduct  from  the  gross 
rent  thus  determined  whatever  may  be  necessary  to  keep 


RENT,    INTEREST,   AND    CAPITALIZATION  221 

buildings,  fences,  etc.,  in  repair,  and  to  restore  to  the  soil 
any  elements  of  fertility  that  have  been  destroyed  in  the 
year's  cropping. 

7.  The  rent  of  any  one  on  I  of  a  nnnibcr  of  classes  of  goods 
united  in  a  permanent  combination  may  be  ascertained  by 
comparison  luith  other  productive  combinations  in  zvhich 
some,  but  not  all,  classes  are  represented. 

In  the  cases  that  have  been  given  the  rent-yielding  ob- 
ject is  a  group  of  capital  goods,  more  or  less  securely 
bound  together  in  use.  The  farm,  for  example,  may  be 
analyzed  into  several  distinct  factors.  One  factor  is  the 
bare  land  ;  another  factor  consists  of  improvements  merged 
in  the  soil,  as  drains  or  irrigation  ditches  ;  a  third  factor 
consists  of  farm  buildings,  fences,  tree  plantations,  etc. 
Some  part  of  the  rent  must  be  ascribable  to  each  one  of 
these  factors.  The  productivity  of  such  a  factor  cannot  be 
found  by  withdrawing  it ;  nor  can  it  be  found  by  treating 
it  as  a  residue,  after  ascertaining  the  shares  of  the  other 
factors  combined  with  it,  for  these  shares  cannot  be  ascer- 
tained directly.  There  remains  the  method  of  compari- 
sons. How  much  more  will  a  well-drained  field  yield  than 
another  field  in  the  vicinity,  of  apparently  equal  natural 
fertility,  but  without  drains  .''  By  such  comparisons  it  is 
usually  possible  to  tell  pretty  nearly  what  each  factor  in 
a  permanent  combination  of  capital  goods  is  producing. 
One  may  distinguish  in  this  way  between  the  rent  paid 
for  a  city  house  and  the  rent  paid  for  the  ground  it  stands 
on,  although'  the  two  rents  usually  make  parts  of  a  single 
payment.  Find  an  equally  spacious  and  costly  house  in 
a  suburb,  where  a  building  lot  is  to  be  had  for  practically 
nothing.  The  difference  in  the  rent  of  the  two  houses 
is  a  fairly  accurate  measure  of  the  rent  of  the  city  lot. 

8.  The  rent  of  an  artificial  capital  good  tends,  in  the  long 
run,  to  equal  interest,  at  the  current  rate,  on  the  cost  of  du- 
plicating the  capital  good. 


222  INTRODUCTION   TO    ECONOMICS 

The  rent  of  a  ship,  a  building,  or  a  machine,  may,  as  we 
have  seen,  be  ascertained,  in  the  first  instance,  by  subtract- 
ing from  the  gross  receipts  arising  from  its  operation  a  sum 
covering  all  other  expenses  connected  with  its  use.  The 
value  of  such  a  rent-bearing  object  does  not  immediately 
affect  the  amount  of  rent  it  yields.  A  ship  that  yields  a  net 
surplus  of  $5000  above  operating  expenses  may  be  worth 
;^5o,ooo  or  ^100,000.  The  value  of  the  ship  has  nothing  to 
do  with  the  amount  of  rent  that  its  owner  will  receive  in 
the  immediate  future.  But  a  ship  is  a  capital  good  that 
requires  periodic  renewal.  Out  of  1000  ships  sailing  the 
ocean  to-day  probably  fifty  are  near  the  end  of  their  eco- 
nomic existence,  and  will  have  to  be  replaced  by  new  ships 
if  the  existing  tonnage  is  to  be  maintained.  Now,  if  the 
rent  of  ships  happens  to  be  so  low  as  not  to  pay  the 
ordinary  rate  of  interest  on  the  capital  represented  by 
the  cost  of  building  them,  no  new  ships  will  be  built 
to  take  the  places  of  those  that  are  no  longer  seaworthy. 
The  aggregate  tonnage  will  thus  be  reduced ;  freights  will 
be  advanced  until  the  rent  of  ships  rises  to  a  figure  which 
affords  a  normal  return  to  shipping  capital.  If,  on  the 
other  hand,  the  rent  of  ships  represents  an  abnormally 
high  return  to  capital,  more  ships  will  be  built,  and  freights 
will  decline  until  the  rent  of  ships  is  only  sufficient  to  pay 
a  fair  rate  of  interest  on  the  capital  invested  in  them.  And 
this  is  in  general  true  of  the  rents  of  all  capital  goods  re- 
quiring periodic  renewal.  I-'"or  a  time  the  rent  may  be  too 
high  or  too  low  to  afford  just  a  normal  return  to  the  capi- 
tal invested  in  such  goods.  In  the  long  run,  however,  the 
rent  is  controlled  by  the  prevailing  rate  of  interest. 

9.  TJie  rent  of  land  is  dependent,  in  large  measure,  upon 
the  rate  of  zvages  and  of  interest  on  auxiliary  capital. 

We  have  seen  how  it  is  possible  to  distinguish  the  rent 
of  the  bare  land  from  the  rent  of  the  improvements  fixed  in 
it.     The  rent  of  land  as  such  is  of  more  practical  impor- 


RENT,   INTEREST,   AND   CAPITALIZATION         223 

tance  than  the  rent  of  any  other  class  of  capital  goods,  as 
land  is  more  frequently  held  under  lease  than  any  other 
class  of  capital  goods.  For  this  reason,  and  because  land 
rent  displays  certain  peculiar  characteristics,  it  is  worth 
while  to  devote  especial  attention  to  a  study  of  the  laws 
determining  it. 

Let  us  assume  that  the  construction  of  a  railway  throws 
open  to  exploitation  a  large  section  of  territory  in  the  Brit- 
ish Northwest,  and  that  all  the  land  is  at  once  bought  up 
by  wealthy  persons  who  intend  to  hold  it  permanently, 
parceling  it  out  in  tracts  suitable  for  tenant  farmers.  We 
shall  further  assume  that  the  owners  of  the  land  leave  its 
equipment  with  auxiliary  capital  goods  entirely  to  the  ten- 
ants, and  that  the  deterioration  of  the  land  is  so  slight  as 
to  be  negligible.  Whatever  the  tenant  can  be  made  to 
pay,  under  these  conditions,  is  practically  the  rent  of  the 
bare  land. 

In  making  up  his  bid  the  tenant  will  have  to  estimate, 
on  the  one  hand,  the  gross  receipts  from  the  land  which  he 
expects  to  occupy,  and  on  the  other  hand,  all  expenses  of 
cultivation,  including  the  wages  of  all  labor  employed,  his 
own  as  well  as  that  of  hired  hands;  interest  on  the  auxiliary 
capital  which  he  furnishes,  whether  his  own  or  borrowed 
capital  ;  and  a  sum  sufficient  to  replace  or  repair  capital 
goods  destroyed  or  impaired  through  use.  Let  us  suppose 
that  all  these  items  of  expense  amount  to  $1000.  If  the 
tenant  has  reason  to  believe  that  one  year  with  another  the 
gross  receipts  from  the  farm  will  be  only  $1000  he  will  pay 
nothing  at  all  to  the  owner  of  the  land  for  its  use.  If  on 
the  other  hand  he  believes  that  the  gross  receipts  will  be 
$2000  he  will  be  prepared  to  pay  a  rent  of  $iooO. 

It  is  obvious  that  what  the  tenant  can  afford  to  pay  for 
the  use  of  the  land  depends,  in  large  measure,  upon  the 
rates  at  which  he  must  reckon  the  wages  of  labor  and  inter- 
est on  auxiliary  capital.     If  these  rates  are  high,  the  deduc- 


2  24  INTRODUCTION   TO   ECONOMICS 

tions  from  gross  receipts  to  be  made  in  calculating  rent  will 
be  large.  Accordingly,  in  order  to  arrive  at  the  forces  de- 
termining the  rent  of  land  in  the  section  which  we  are  study- 
ing, we  must  examine  the  influences  affecting  the  local  rates 
of  wages  and  interest. 

Land  in  the  Canadian  Northwest,  as  in  every  other  part 
of  the  world,  varies  in  natural  fertility  and  in  accessibility. 
If  the  supply  of  auxiliary  capital  and  of  labor  is  very  small, 
only  the  most  fertile  and  most  accessible  lands  will  be 
cultivated.  The  owners  of  slightly  poorer  or  slightly  less 
accessible  lands  will  of  course  derive  no  revenue  from  them  ; 
they  could  afford  to  let  such  lands  for  a  nominal  rent.  On 
these  lands,  then,  labor  and  auxiliary  capital  are  free  to 
divide  between  them  whatever  they  can  produce.  The  labor 
and  auxiliary  capital  employed  on  the  better  land  can 
demand  at  least  as  much  for  themselves ;  if  this  is  refused, 
they  will  migrate  to  the  unoccupied  fields. 

Now  let  us  suppose  that  a  new  body  of  laborers,  bring- 
ing with  them  the  appropriate  auxiliary  capital,  enter  the 
region.  These  occupy  the  lands  which  in  fertility  and  acces- 
sibility are  least  inferior  to  those  first  cultivated.  If  after 
this  accession  of  labor  and  capital  any  one  is  dissatisfied 
with  wages  on  the  better  lands,  he  may,  as  before,  migrate 
to  land  still  remaining  unoccupied.  But  the  unoccupied 
land  is  now  more  remote  and  less  fertile  than  was  that  exist- 
ing before  the  accession  of  the  new  labor  and  capital,  and 
the  product  of  labor  and  capital  on  such  lands  will  be  less. 
The  cultivator  of  the  better  grade  of  land  will  therefore 
not  have  to  pay  so  much  for  either  factor  as  before.  A 
larger  share  of  his  gross  receipts  may  therefore  be  paid  out 
in  rent.  And  with  every  increase  in  the  labor  and  auxiliary 
capital  of  the  community,  remoter  and  less  fertile  lands  are 
brought  under  cultivation,  with  consequent  decline  in  wages 
and  in  interest  on  auxiliary  capital,  and  increase  in  the  rent 
of  all  the  better  grades  of  land.     At  any  particular  time  we 


RENT,    INTEREST,   AND    CAPITALIZATION  225 

may  say  that  in  this  community  the  wages  of  labor  and  the 
interest  on  auxiliary  capital  are  determined,  respectively,  by 
the  productivity  of  labor  and  of  auxiliary  capital  on  the 
poorest  land  actually  cultivated.  This  is  of  course  only 
a  special  instance  of  the  law  stated  in  earlier  chapters, 
that  wages  and  interest  are  determined  by  marginal  prod- 
uctivity. 

From  the  fact  that  when  labor  and  capital  flow  into  a 
new  region  the  rent  of  land  steadily  rises,  it  is  often  assumed 
that  the  aggregate  of  land  rents  is  constantly  increasing. 
But  it  is  to  be  borne  in  mind  that  when  labor  and  capital  are 
drawn  into  a  new  region,  the  older  communities  may  come 
to  be  less  fully  supplied  than  before.  And  this  would  in- 
crease the  shares  of  labor  and  of  auxiliary  capital  in  those 
communities,  and  reduce  the  share  that  is  assigned  to  land. 
The  increase  in  rents  in  America,  in  the  last  half  century,  has 
in  some  measure  been  offset  by  a  decline  in  rents  in  Europe. 
If,  however,  population  and  capital  in  reproducible  forms 
continue  to  increase,  without  any  corresponding  increase  in 
the  amount  of  land  accessible  to  the  cultivator,  and  without 
improvements  that  increase  the  general  productivity  of  labor 
and  capital,  the  aggregate  of  land  rent  must  increase. 

10.  A  rise  in  tJic  prices  of  agricultural  products  visually 
raises  the  rent  of  land. 

In  the  foregoing  example  we  have  assumed  that  the 
value  of  the  product  of  a  farm  remains  fixed,  while  the 
rates  of  wages  and  interest  vary.  Let  us  now  see  what 
would  be  the  effect  on  rent  of  an  increase  in  the  value  of  the 
product  —  which  we  shall  assume  to  be  wheat.  Such  an 
increase  might  be  brought  about  by  a  reduction  in  the  cost 
of  transportation.  For  the  local  price  of  wheat  is  practi- 
cally equal  to  the  price  in  England,  the  great  wheat  market 
of  the  world,  less  the  cost  of  transporting  the  wheat  thither. 
If  the  cost  of  transportation  is  reduced  five  cents  a  bushel, 
the  local  price  of  wheat  will  rise  five  cents  a  bushel. 


226  INTRODUCTION   TO   ECONOMICS 

If  the  growers  of  wheat  are  forced  to  rely  upon  the 
local  supplies  of  labor  and  capital,  the  effect  of  the  rise  in 
the  price  of  wheat  will  be  an  increase  in  wages  of  labor 
and  interest  on  auxiliary  capital  ;  the  rent  of  land  will 
rise  proportionally.  For  under  the  conditions  assumed, 
wages  and  interest  are  determined  by  the  value  of  the 
product  of  these  agents  on  the  poorest  lands  in  the  com- 
munity actually  in  use.  The  value  of  this  product  will  be 
increased  by  the  rise  in  the  price  of  wheat;  hence  wages 
and  interest  will  rise  throughout  the  territory.  Since  there 
has  been  no  increase  in  the  amount  of  labor  and  capital,  no 
more  land  can  be  cultivated  than  before.  The  better  lands 
can  claim  no  larger  a  return,  measured  in  wheat,  than 
before ;  but  this  return  now  commands  a  higher  price. 

If,  on  the  other  hand,  close  relations  have  been  estab- 
lished between  this  region  and  the  rest  of  the  world,  so 
that  wages  and  interest  are  determined  by  the  general  in- 
fluences prevailing  in  society,  practically  the  whole  of  the 
advance  in  wheat  prices  will  be  applied  to  rent.  For  sup- 
pose that  at  first  wages  and  interest  are  raised  above  the 
general  level.  Additional  labor  and  capital  will  flow  into 
the  region  ;  competition  will  arise  for  employment  on  the 
better  lands,  or  worse  lands  will  be  put  under  cultivation. 
Thus  the  marginal  productivity  of  labor  and  of  auxiliary 
capital  will  be  reduced  and  the  rent  of  land  wall  increase, 
until  labor  and  capital  are  rewarded  no  better  than  they 
were  before  —  that  is,  until  land  rent  has  absorbed  the 
entire  benefit  of  the  increase  in  price.  It  is  true  that  the 
withdrawal  of  labor  and  capital  from  the  general  field  that 
this  movement  implies  will  tend  to  raise  the  rewards  of 
these  agents  slightly.  But  this  influence  will  be  hardly 
perceptible. 

We  can  now  understand  what  it  is  that  forces  up  agri- 
cultural rents  in  the  vicinity  of  a  growing  city.  The  value 
of  the  gross  product  of  a  given  area  is  constantly  increas- 


RENT,   INTEREST,    AND    CAPITALIZATION  227 

ing,  as  a  result  of  increased  demand,  while  the  charges  to 
be  deducted,  wages  and  interest  on  capital  in  reproducible 
forms,  are  controlled  by  general  laws  which  are  affected 
only  slightly,  if  at  all,  by  the  growth  of  this  particular  city. 
We  can  explain  in  the  same  way  the  rise  of  rent  of  city 
lots.  The  aggregate  profits  from  the  business  that  may 
be  transacted  on  a  given  ground  space  increase  with  the 
growth  of  a  city,  and  as  wages  and  interest  on  reproducible 
capital  do  not  increase  in  equal  degree,  a  larger  surplus  is 
left  for  the  owner  of  the  land.  In  the  same  way  the  rent 
of  a  railway  or  a  canal  in  a  rapidly  developing  region 
steadily  increases.  The  railway  or  canal  is  a  capital  good 
which  cannot  readily  be  reproduced.  Accordingly,  if  the 
aggregate  business  to  be  carried  on  increases,  an  increas- 
ing share  of  the  value  product  of  the  business  will  take  the 
form  of  rent  on  the  irreproducible  elements. 

11.  GrotvtJi  of  population  and  increase  in  accumulations 
tend  to  raise  ground  rejits  generally. 

In  all  the  cases  that  we  have  examined,  an  important 
factor  in  raising  rents  of  land  and  similar  capital  goods  is 
the  influx,  or  possibility  of  influx,  of  capital  and  labor  from 
the  general  field.  If  we  view  society  as  a  whole,  there  is, 
of  course,  no  possibility  of  a  similar  influx  of  labor  and 
capital  from  outside  regions.  Nothing  can  transfer  to  the 
owners  of  land  the  benefits  of  increased  value  product  ex- 
cept increase  in  the  aggregate  supply  of  labor  and  auxil- 
iary capital.  If  these  agents  remain  stationary  in  quantity, 
while  the  progress  of  improvements  raises  the  productivity 
of  the  units  that  are  placed  at  the  greatest  disadvantage  — 
that  is,  if  general  wages  and  interest  rise  —  it  is  obvious 
that  the  rent  of  land  may  fall.  So  also  if  population  and 
auxiliary  capital  decrease  in  amount.  If,  on  the  other 
hand,  labor  and  auxiliary  capital  increase  so  rapidly  that 
wages  and  the  interest  on  such  capital  fall,  land  rents  must 
in  general  rise.     It  is,  of  course,  possible  that  increase  of 


>28  INTRODUCTION   TO   ECONOMICS 

capital  and  of  labor  may  be  attended  by  such  great  im- 
provements in  methods  of  production  that  wages,  interest 
on  reproducible  capital  goods,  and  land  rent  will  all  in- 
crease. This  has  been  more  or  less  true  of  the  economic 
development  of  the  last  century. 

12.  TJie  process  of  computing  the  anwimt  of  capital  in  a 
good  f'om  its  net  rent  is  termed  capitalization. 

/  Given  the  net  rent  of  a  capital  good  and  the  current  rate 

of  interest  on  capital,  it  is  an  easy  matter  to  ascertain  the 
amount  of  capital  invested  in  the  good.  Multiply  the  sum 
representing  the  usual  net  rent  by  the  quotient  arrived  at 
by  dividing  lOO  by  the  number  representing  the  rate  of 
interest.  If  the  net  rent  of  a  farm  is  $2500  and  the 
current  rate  of  interest  is  five  per  cent,  the  capital  value  of 
the  farm  is  i§^X25oo,  or  $50,000.  This  process  of  com- 
puting the  capital  through  the  net  rent  is  known  as  capitali- 
zation. If  a  building  earns  $10,000  a  year,  and  there  is 
good  reason  for  believing  that  it  will  continue  to  earn  the 
same  net  rent  indefinitely,  the  simplest  way  of  ascertaining 
how  much  capital  is  invested  in  the  building  is  to  find  how 
large  a  sum  of  capital,  in  general  investments,  is  required 
to  earn  an  equal  sum.  If  the  general  rate  of  interest  is  ten 
per  cent,  this  sum  will  be  $100,000.  If  the  rate  of  interest 
is  five  per  cent,  the  sum  will  be  $200,000.  In  the  one  case 
the  rent  is  capitalized  at  ten  per  cent,  in  the  other  case  at 
five  per  cent. 

13,  Tlie  amount  of  capital  in  a  reproducible  capital  good 
is  determined  by  its  cost  of  duplication.  The  amount  of 
capital  in  capital  goods  that  cannot  be  replaced  is  determined 
by  the  capitalization  of  their  rent. 

In  the  case  of  reproducible  capital  goods,  the  net  rent 
alone  is  no  sufficient  indication  of  capital  value.  The  cost 
of  producing  similar  goods  must  be  taken  into  account ; 
indeed,  this  is  by  far  the  more  important  element  in  the 
computation.     A  ship,  for  example,  may  yield  a  net  rent 


RENT,   INTEREST,   AND    CAPITALIZATION         229 

of  ;^  1 0,000  at  a  time  when  the  current  rate  of  interest  is  five 
per  cent.  It  would,  however,  be  a  reckless  business  man 
who  would  assume,  from  these  data,  that  the  ship  represents 
a  capital  of  $200,000,  and  that  he  could  afford  to  pay  that 
sum  for  it.  If  a  similar  ship  can  be  built  for  $100,000,  this 
sum  is  the  true  measure  of  the  capital  invested.  The  net 
rent  of  $10,000  merely  indicates  that  capital  in  ships  is,  for 
the  time,  highly  productive.  Soon  the  supply  of  ships  will, 
doubtless,  be  increased  and  the  net  rent  will  fall  to  about 
^5000.  It  may  be  a  year  before  the  decline  will  take  place; 
in  such  case  the  buyer  of  a  ship  already  afloat  can  afford  to 
pay  about  $105,000  for  it.  This  sum  may  be  analyzed  into 
two  parts;  $100,000  for  the  capital  in  the  ship,  and  $5000 
for  the  transfer  of  the  extra  productivity  of  the  ship  through 
one  year.  If  several  years  must  elapse  before  the  net  rent 
of  ships  falls,  the  second  element  in  the  price  of  the  ship 
will  be  placed  at  a  higher  figure ;  and  if  in  some  way  this 
extra  productivity  could  be  made  perpetual  —  if  the  ship, 
worth  originally  $100,000,  could  be  made  to  yield  indefi- 
nitely $5000  in  addition  to  the  normal  earnings  of  the  capi- 
tal invested  in  it  —  the  buyer  could  afford  to  pay  as  much 
for  this  extra  product  as  for  the  original  capital.  That  is, 
he  would  arrive  at  the  value  of  the  ship,  not  through  a  com- 
putation of  its  cost  of  production,  but  through  a  capitaliza- 
tion of  its  entire  net  rent. 

Now,  a  tract  of  land  is  a  capital  good  in  a  situation 
analogous  to  that  of  the  ship  in  our  hypothetical  case.  The 
capital  invested  in  the  land,  in  the  first  instance,  may  have 
been  nothing  at  all.  But  if  the  land  yields  a  net  rent  of 
$5000  a  year,  that  fact  is  the  only  one  that  buyer  or  seller 
will  need  to  consider.  For  it  is  not  possible  that  the  supply 
of  similar  pieces  of  land  at  the  command  of  society  will  be 
so  increased  that  the  net  rent  will  shrink  to  zero,  as  would 
be  the  case  with  a  reproducible  good  originally  costing 
nothing.     Because  of  the  natural  limitation  upon  the  supply 


230  INTRODUCTION   TO    ECONOMICS 

of  land,  there  is  good  reason  for  supposing  that  the  existing 
rent  will  continue  to  be  paid  indefinitely.  The  right  to  re- 
ceive the  ^5000  land  rent  for  all  time  is  therefore  worth 
just  as  much  as  the  possession  of  a  capital  in  reproducible 
forms  yielding  $5000  interest  annually.  If  capital  in  re- 
producible goods  yields,  as  a  rule,  ten  per  cent,  the  rent  of 
the  land  will  be  capitalized  at  $50,000 ;  if  the  current  rate 
on  such  capital  is  only  five  per  cent,  the  rent  will  be  capi- 
talized at  $100,000. 

Shall  we  say  that  a  tract  of  land  that  yields  $5000  rent, 
and  is  capitalized  at  $100,000,  is  really  a  capital  of  $100,000, 
or  shall  we  say  that  the  real  capital  in  the  land  is  only  the 
sum  originally  employed  to  clear  it  and  render  it  fit  for 
economic  use.''  If  we  adopt  the  former  mode  of  expression, 
we  shall  regard  the  capital  in  the  land  as  no  more  productive 
than  capital  in  any  other  form.  If  we  adopt  the  latter  mode 
of  expression,  we  shall  regard  the  capital  in  the  land  as 
extraordinarily  productive.  Business  men,  and  many  mod- 
ern economists,  adopt  the  former  mode  of  expression.  A 
property  that  yields  regularly  the  income  of  a  capital  of 
$100,000  is  a  capital  of  $100,000. 

It  matters  little  what  mode  of  expression  we  employ  so 
long  as  we  bear  in  mind  the  fact  that  the  value  of  the  land 
is  merely  the  capitalization  of  its  rent  at  the  current  rate  of 
interest;  that  with  an  increase  in  the  rent  of  a  given  tract 
of  land,  if  interest  on  capital  in  reproducible  goods  remains 
unchanged,  the  capital  value  of  the  land  automatically 
increases,  until  the  ratio  of  the  capital  value  of  land  to  its 
net  rent  is  the  same  as  the  ratio  of  the  capital  value  of  a 
group  of  typical  reproducible  capital  goods  to  their  net  rent; 
that  with  a  decline  in  the  interest  rate  on  capital  in  repro- 
ducible goods,  the  value  of  land  yielding  a  given  rent 
increases  until  the  rate  of  interest  on  so-called  capital  in 
land  is  no  higher  than  the  rate  of  interest  on  other  forms  of 
capital.     If  the  rate  of  interest  on  capital  in  reproducible 


RENT,   INTER F':ST,    AND    CAPITALIZATION         23 1 

capital  goods  falls,  it  is  because  the  earning  power  of  such 
goods  declines.  If  the  rate  of  interest  on  capital  in  land 
declines,  it  is  usually  because  the  land  is  revalued  at  a 
higher  figure  —  that  is,  counts  for  a  larger  sum  of 
capital. 

14.  Increase  in  the  capital  of  society  causes  the  value  of 
land  to  rise  for  tivo  reasons,  (i)  because  it  raises  the  rent  of 
land,  and  {2)  because  it  changes  the  rate  at  which  a  given 
rental  is  capita  I/. zed. 

We  have  already  seen  that  with  increase  in  the  social 
fund  of  reproducible  capital  the  productivity  of  such  capi- 
tal declines;  the  rate  of  interest  falls,  and  a  larger  share 
of  the  product  of  society  takes  the  form  of  ground  rent. 
This  of  itself  would  have  the  effect  of  increasing  the  capi- 
tal value  of  land.  The  decline  of  the  interest  rate  affects 
the  value  of  land  further  through  changing  the  rate  at 
which  a  given  rent  is  capitalized.  If  the  current  rate  of 
interest  is  ten  i)cr  cent,  a  certain  field  may  produce  a  net 
rent  of  $1000.  This  sum,  capitalized  at  ten  per  cent, 
gives  a  value  of  $10,000,  which  we  may,  if  we  choose, 
call  the  capital  invested  in  the  field.  At  the  end  of  two 
decades  the  current  rate  of  interest  may  have  fallen  to  five 
per  cent.  This  would  naturally  increase  the  rent  of  the 
field  in  question  —  perhaps  to  $2000.  This  rent  we  must 
now  capitalize,  not  at  ten  per  cent,  as  formerly,  but  at  the 
new  current  rate  of  five  [)er  cent.  The  value  of  the  land 
thus  comes  to  be  $40,000. 
15.    Summary. 

Rent,  in  the  most  general  sense  of  the  term,  is  the 
product  of  any  concrete  capital  good.  For  practical 
reasons,  however,  a  study  of  rent  may  best  be  limited 
to  goods  of  a  fairly  permanent  character.  The  gross 
return  to  a  capital  good  may  be  divided  into  two  parts, 
•one  of  which  serves  to  replace  the  good  when  it  is  worn 
out,  while  the  other  is  a  net  income  to  the  owner  of  the 


232  INTRODUCTION    TO    ECONOMICS 

good.     This  net  income,  or  net  rent,  may  be  regarded  as 
the  sum  of  interest  on  the  capital  embodied  in  the  good. 

In  practice,  the  rent  of  a  durable  capital  good  may  con- 
veniently be  treated  as  a  residue  remaining  after  the  cost 
of  labor  and  of  perishable  goods  has  been  deducted  from 
the  aggregate  product.  Where  several  durable  goods  en- 
ter into  a  permanent  combination,  the  rent  of  any  one 
may  be  determined  by  comparison  with  other  combinations 
into  which  this  particular  good  does  not  enter. 

The  rent  of  reproducible  capital  goods  tends,  in  the 
long  run,  to  equal  interest,  at  the  current  rate,  on  the  cost 
of  duplicating  such  goods.  The  rent  of  goods  that  can- 
not be  duplicated,  such  as  land,  can  be  arrived  at  only 
through  a  study  of  the  forces  determining  wages,  interest 
on  reproducible  capital,  and  other  outlays  in  production. 
As  wages  and  interest  fall,  or  as  value  of  product  rises, 
the  rent  of  such  goods  increases.  The  value  of  irrepro- 
ducible  capital  goods  is  arrived  at  through  a  capitalization 
of  their  rent  at  the  current  rate  of  interest.  In  a  develop- 
ing country  land  values  rise  on  account  of  increase  in 
rent  and  on  account  of  decline  in  the  interest  rate  serv- 
ing as  a  basis  of  capitalization. 


CHAPTER   XIV 

ENTERPRISE   AND   BUSINESS   PROFITS 

1.  Exceptionally  favorable  opportunities  for  the  employ- 
ment of  labor  and  capital  are  to  be  found  in  evcjy  progress- 
IV e  society. 

In  many  parts  of  the  United  States  a  careful  observer  of 
business  conditions  will  note  neglected  opportunities  for 
the  production  of  wealth.  In  one  section  of  the  country 
there  is  a  great  demand  for  thoroughbred  stock  ;  very  high 
prices  are  paid  for  such  stock,  yet  men  are  slow  to  equip 
themselves  for  meeting  the  demand.  Another  section  of 
the  country  is  known  to  present  excellent  opportunity  for 
the  production  of  high  grade  fruit,  yet  it  has  few  orchards, 
and  these  of  indifferent  quality.  Fertile  lands  are  to  be 
found  that  yield  scarcely  anything  for  lack  of  water,  yet 
plenty  of  water  for  irrigation  is  at  hand  in  a  near-by  stream. 
Waterfalls  offering  abundance  of  cheap  power  remain  for 
years  unutilized. 

Nor  are  exceptional  opportunities  for  wealth  production 
limited  to  the  exploitation  of  neglected  natural  sources  of 
wealth.  The  richest  opportunities  are  often  those  of  or- 
ganizing in  a  more  effective  way  businesses  already  exist- 
ing. In  a  dairying  country,  when  each  producer  works  in 
ignorance  of  what  other  producers  are  doing,  he  must  learn 
through  experience  many  facts  concerning  methods  of 
production  and  marketing  that  could  be  learned  much  more 
cheaply  through  the  experience  of  others.  Moreover,  the 
product  of  such  a  country  lacks  uniformity  and  its  supply 
is  very  irregular,  with  the  result  that  prices  are  unnecessa- 
rily low  and  fluctuate  seriously.  An  organization  of  the 
producers  may  decidedly  increase  their  income. 

233 


234  INTRODUCTION   TO   ECONOMICS 

In  earlier  chapters  we  have  seen  what  advantages  flow 
from  the  concentration  and  combination  of  production. 
At  a  particular  time  there  is  one  form  of  organization  best 
adapted  to  the  circumstances,  and  to  introduce  this  form 
of  organization  offers  an  opportunity  for  rich  reward  to  the 
man  or  men  who  are  enterprising  enough  to  undertake  the 
task. 

In  less  conspicuous  form,  exceptional  opportunities  are 
continually  presenting  themselves.  In  a  certain  city  there 
is  a  corner  lot,  now  occupied  by  a  tumble-down  dwelling 
house,  that  would  furnish  an  excellent  location  for  a  gro- 
cery or  hardware  business.  A  block  of  ground  in  the  resi- 
dence part  of  the  city,  now  occupied  by  a  few  old  cottages, 
could,  in  view  of  present  conditions,  be  profitably  cleared 
and  sold  in  large  lots  to  persons  intending  to  build  expen- 
sive homes.  It  may  be  said,  in  general,  that  whenever  a 
new  business  is  undertaken,  it  is  with  the  purpose  of  ex- 
ploiting a  preexisting  opportunity  for  exceptional  returns. 
The  same  thing  is  true  when  an  established  business 
enters  new  fields  of  activity. 

2.  The  function,  of  combining  labor  mid  capital  for  the 
purpose  of  exploiting  a  biisiness  opportunity  is  ktiozvn  in 
economics  as  enterprise. 

In  a  growing  town  the  time  has  become  ripe  for  the 
establishment  of  a  wholesale  grocery  business.  Months 
and  years  may  pass  before  any  one  undertakes  to  supply 
the  need  for  such  a  business,  but  eventually  a  man  of  suffi- 
cient business  prestige  to  command  confidence  proceeds  to 
get  together  the  requisite  funds  for  launching  the  business. 
He  may  be  wealthy  enough  to  supply  the  necessary  capi- 
tal himself;  he  may  supply  a  part  of  it  and  borrow  the 
rest;  or  he  may  associate  with  him  in  the  enterprise  other 
persons  having  capital.  The  organizing  of  the  business 
involves  labor  on  his  part,  and  some  of  it  of  a  very  high 
order.     The  essential  part  of  his  activity  is  not,  however, 


ENTERPRISE    AND    BUSINESS    PROFITS  235 

the  labor  involved.  What  differentiates  him  from  a  laborer 
working  in  a  routine  way  is  the  fact  tliat  he  sees  a  new 
opportunity  clearly  and  takes  the  steps  necessary  to  utilize 
it.  And  the  reward  which  he  anticipates  consists,  not  in 
wages  for  his  labor,  but  in  the  exceptional  returns  to  all 
labor  and  capital  employed,  from  which  he  expects  a  share 
for  himself. 

The  man  who  performs  the  function  of  combining  labor 
and  capital  for  the  exploitation  of  an  opportunity  is  known 
in  economics  as  the  enterpriser,  or  entrepreneur. 

To  illustrate  the  functions  of  the  enterpriser,  we  will 
suppose  that  a  man  of  known  integrity  and  business  capac- 
ity decides  to  establish  a  manufacturing  business.  He 
borrows  at  a  stipulated  rate  of  interest  all  the  capital  that 
the  enterprise  requires.  The  actual  work  of  the  business 
man  himself,  we  will  say,  is  a  negligible  minimum.  His 
secretaries  collect  the  information  on  which  he  acts  in  de- 
ciding to  found  such  a  business.  His  attorneys  arrange 
the  details  of  the  loan  contract;  his  banker  finds  for  him 
the  persons  who  have  capital  to  lend.  Even  the  business 
of  selecting  a  building  and  choosing  a  responsible  manager 
is  given  over  to  salaried  employees.  What,  then,  is  the 
connection  of  the  business  man  with  the  enterprise.'*  He 
lends  it  his  name,  he  assumes  legal  responsibility  for  the 
conduct  of  the  business,  and  he  reserves  to  himself  the  ul- 
timate power  of  approving  or  vetoing  proposals  made  by 
his  staff.  These  are  the  only  functions  that  the  enter- 
priser must  necessarily  retain. 

In  real  Hfe  it  would  be  difficult  to  find  a  man  who  is  an 
enterpriser  and  nothing  more.  It  is  rarely  the  case  that 
a  man  without  capital  can  borrow  any  considerable  amount 
of  it.  Lenders  demand  the  security  that  only  the  owner 
of  independent  resources  can  give.  He  would,  moreover, 
be  a  fortunate  enterpriser  who  could  find  secretaries  and 
managers  who  can  be  trusted  to  the  extent  we  have  as- 


236  INTRODUCTION   TO    ECONOMICS 

sumed.  A  part  of  the  labor  of  oversight  must  ordinarily 
be  performed  by  the  business  man  himself.  The  fact  that 
the  same  man  ordinarily  combines  in  himself  the  functions 
of  enterpriser,  laborer,  and  capitalist  does  not,  however, 
make  the  functions  indistinguishable. 

3.  Opportunities  for  enterprise  are  most  common  wJiere 
economic  conditions  are  rapidly  changing. 

When  the  population  of  a  city  increases  rapidly,  oppor- 
tunities for  new  business  enterprises  emerge  one  after 
another.  Profits  are  to  be  made  by  converting  residential 
districts  to  business  uses,  and  by  opening  up  new  residen- 
tial districts  upon  lands  adjacent  to  the  city.  Increase  in 
the  number  of  large  incomes  in  a  city  offers  opportunity 
for  businesses  catering  to  the  tastes  of  the  rich.  The  in- 
creasing numbers  of  persons  without  means  renders  pos- 
sible the  establishment  of  new  manufacturing  enterprises. 
A  multitude  of  business  opportunities  arise  when  a  new 
railway  line  is  opened;  when  improvements  are  made  in 
the  means  of  producing  or  transmitting  power;  when  the 
tastes  of  consumers  undergo  a  marked  change.  Enter- 
prise languishes,  on  the  other  hand,  where  population  is 
stationary  and  habits  of  consumption  are  fixed.  Inventions 
of  a  far-reaching  character  may  give  a  fillip  to  enterprise 
even  in  such  a  community;  but  after  a  time  readjustments 
are  made,  and  enterprise  again  becomes  dormant.  It  is  in 
new  and  developing  countries  like  the  United  States  where 
enterprise  assumes  its  highest  importance. 

4.  Enterprise  off  en  entails  risks,  but  this  is  not  necessarily 
the  case. 

An  enterprising  person,  struck  by  the  natural  beauties  of 
a  mountain  valley,  decides  to  erect  a  summer  hotel.  He 
sinks  his  own  capital  and  whatever  capital  he  can  borrow 
in  erecting  a  building  and  in  improving  the  grounds  about 
it.  The  outcome  may  greatly  exceed  his  expectations; 
throngs  of  patrons  may  seek  admission  to  the  hotel,  en- 


ENTERPRISE   AND    BUSINESS    PROFITS  237 

abling  him  to  fix  his  charges  at  a  very  high  level;  and  even 
this  may  increase  the  popularity  of  his  house,  since  high 
charges  are  often  accepted  as  a  guaranty  of  exclusiveness  — 
the  quality  for  which  men  are  most  willing  to  pay  liberally. 
The  event  may,  however,  be  far  less  favorable;  a  few  strag- 
gling seekers  for  rest  and  quiet  may  be  the  only  patrons 
secured,  and  these  may  hardly  pay  the  running  expenses 
of  the  business.  In  such  a  case  the  enterpriser  loses  not  only 
his  prospects  of  prosperity;  he  also  loses,  for  all  practical 
purposes,  whatever  capital  he  has  embarked  in  the  enter- 
prise. 

Many  enterprises,  however,  involve  no  risk.  When  a 
railway  opens  a  new  country,  much  of  the  land  along  the 
route  is  certain  to  rise  in  value,  and  those  who  are  enterpris- 
ing enough  to  buy  before  the  rise  are  certain  of  a  substan- 
tial return.  The  success  of  many  enterprises  involving  or- 
ganization is  capable  of  almost  mathematical  demonstration. 
The  exact  measure  of  profit  is  usually  uncertain,  but  that 
such  an  enterprise  will  afford  the  requisite  minimum  of 
return,  may  be  clearly  shown.  The  highest  type  of  enter- 
priser is  the  one  who  places  nothing  at  stake  until  his  cal- 
culations prove  that  there  is  practically  no  chance  of  loss. 

5.  TJie  existence  of  valuable  opportunities  invohiug  no 
risk  implies  the  fact  that  competition  docs  not  operate  freely. 

The  question  naturally  arises,  how  can  opportunities  in- 
volving no  risk,  or  little  risk,  be  found  }  If  competition 
were  keen,  each  opportunity  would  be  seized  upon  as  soon 
as  the  chances  of  gain  seemed  to  outweigh  the  chances  of 
loss.  But  competition  seldom  operates  perfectly.  Many 
■men  are  conservative,  and  show  a  preference  for  the  well- 
established  routine.  These  men  overlook  most  of  the  op- 
portunities within  their  reach.  Other  men  see  the  oppor- 
tunities, but  through  lack  of  capital,  business  prestige,  or 
managing  ability,  arc  not  in  a  position  to  avail  themselves 
of  the  opportunities  that  are  presented.     This  is  especially 


238  INTRODUCTION    TO    ECONOMICS 

the  case  where  the  initial  outlay  required  is  a  large  one. 
You  may  know  of  an  opportunity  for  the  profitable  invest- 
ment of  $100,000;  but  if  you  have  no  capital  of  your  own, 
you  will  find  it  almost  impossible  to  induce  other  men  even 
to  listen  to  your  project.  The  opportunity  will  probably 
wait  for  the  man  who  has  both  enterprise  and  $100,000,  or 
sufficient  business  prestige  to  induce  other  men  to  intrust 
him  with  their  capital. 

6.  The  income  zvhich  originates  in  enterprise  is  known  as 
profit.  It  may  be  defined  as  a  surplus  remaining  after  costs, 
including  interest  on  all  capital  and  ivages  for  all  labor, 
have  been  met. 

In  earlier  chapters  it  has  been  shown  that  the  returns 
to  the  average  business  enterprise  must  be  sufficient  to 
cover  all  costs  of  production,  including  under  this  head  not 
only  actual  outlays,  such  as  prices  paid  for  materials,  wages 
of  hired  labor,  and  interest  on  borrowed  capital,  but  also 
ordinary  returns  on  the  capital  owned  by  the  business  man 
himself  and  a  reasonable  wage  for  his  labor.  An  excep- 
tional opportunity  is  one  that  will  do  more  than  this.  A 
surplus  remains  in  the  hands  of  the  enterpriser  after  all 
costs  have  been  met.  This  surplus  is  known  in  economics 
as  "pure  profit,"  or  more  simply,  as  "profit."  We  must  be 
careful  to  distinguish  profit  in  this  sense  of  the  term  from 
the  income  known  as  profit  in  the  language  of  business. 
In  the  latter  sense  profit  often  includes  interest  on  the 
enterpriser's  capital  and  wages  for  his  labor.  Profit  in  the 
economic  sense  of  the  term  is  not  essential  to  the  continued 
operation  of  an  established  enterprise.  Profit  in  the  busi- 
ness sense  of  the  term  is  a  necessary  income,  since  no  one' 
would  remain  long  in  a  business  unless  he  obtained  a  re- 
turn representing  interest  on  his  capital  and  wages  for 
his  labor. 

7.  TJie  profits  from  an  enterprise  are  commonly  due  to  the 
fact  that  labor  and  capital,  in  that  enterprise,  are  nnusiially 


ENTERPRISE    AND    BUSINESS    PROFITS  239 

productive,  bitt  are  rewarded  according  to  the  standards  gen- 
erally prevailing. 

In  any  important  industrial  center  the  productivity  of 
labor  and  of  capital  may  at  a  given  time  vary  from  industry 
to  industry,  while  the  wages  of  labor  and  interest  on  loan- 
able capital  vary  little,  if  at  all.  We  may  arrange  the 
different  industries  of  such  a  center  in  a  series,  according 
to  the  degree  of  productivity  of  labor  and  capital  in  each 
one.  Labor  and  capital  will,  as  a  rule,  receive  no  higher 
rewards  in  any  industry  than  in  the  one  that  stands  lowest 
in  the  series.  If  we  assume  that  in  this  least  productive 
industry  labor  and  capital  receiv^e  all  that  they  produce  — 
and  we  cannot  assume  that  they  receive  more  than  this  — 
we  see  clearly  that  they  must  receive  less  than  they  pro- 
duce in  all  the  industries  higher  in  the  series.  In  the  more 
productive  industries  the  products  of  labor  and  capital 
afford  a  surplus  above  wages  and  interest,  which  takes  the 
form  of  a  profit  to  the  enterpriser. 

Let  us  suppose  that  the  American  public,  awakening  to 
the  significance  of  the  ghastly  record  of  railway  accidents, 
insists  that  steel  passenger  coaches  replace  the  wooden 
cars  now  in  use,  and  withholds  its  patronage  from  railway 
companies  that  refuse  to  change  their  equipment.  The 
demand  for  steel  cars  would  become  enormous.  The  car- 
building  companies,  for  a  time,  could  sell  their  output  at 
very  high  prices.  The  productivity  of  labor  and  capital 
in  such  establishments,  measured  in  terms  of  price,  would 
be  abnormally  high.  Hut  the  wages  of  laborers  engaged 
in  building  steel  cars  would  be  practically  no  higher  than 
the  wages  of  equally  skilled  laborers  in  any  other  branch 
of  the  iron  and  steel  industries.  There  would  accordingly 
be  a  surplus  above  costs,  or  a  profit  to  the  enterpriser.  The 
car-building  companies  would  pay  no  higher  rate  of  interest 
on  borrowed  capital  than  any  other  manufacturing  com- 
panies in  the  vicinity.     A  surplus  originating  in  the  ab- 


240  INTRODUCTION   TO   ECONOMICS 

normally  high  productivity  of  capital  would  thus  be  added 
to  the  profit  from  labor. 

In  any  industry  the  productivity  of  labor  and  capital 
may  vary  from  establishment  to  establishment,  although 
there  may  be  no  variation  in  the  rates  of  wages  paid.  We 
may,  if  we  like,  arrange  the  establishments  in  a  series,  ac- 
cording to  the  degree  of  productivity  of  labor  and  capital, 
just  as  we  did  in  the  case  of  industries  of  varying  produc- 
tivity. No  higher  wages  or  interest  will  be  paid  by  any 
establishment  than  by  the  establishment  working  at  the 
greatest  disadvantage.  As  this  establishment  will  pay  to 
labor  and  capital  no  more  than  these  agents  produce,  it 
follows  that  the  better  establishments  will  not  need  to 
pay  out  in  wages  and  interest  the  whole  product  of  labor 
and  capital.     A  profit  is  left  over  for  the  enterpriser. 

8.  Profits,  in  some  instances,  are  explained  by  the  fact 
that  hibor  arid  capital,  though  not  more  than  normally  pro- 
ductive, are  secured  at  abnormally  low  rates. 

Certain  classes  of  laborers  are  in  an  exceptionally  weak 
position,  and  may  be  compelled  to  accept  wages  decidedly 
lower  than  the  prevailing  rate.  Immigrants  from  countries 
with  a  different  language  and  a  lower  standard  of  life 
must  often  accept  conditions  of  employment  that  are 
exceedingly  unfavorable.  In  some  cases,  indeed,  they 
have  been  held  in  qnasi-hondo-gQ  and  compelled  to  work 
at  wages  that  are  unreasonably  low.  Where  employers 
are  of  one  race  and  employees  of  another,  a  set  of  institu- 
tions may  develop  which  give  the  employer  whatever  re- 
mains of  the  product  of  labor  above  a  mere  minimum  of 
subsistence.  In  some  parts  of  the  United  States  convicts 
and  persons  condemned  to  the  workhouse  are  farmed  out 
at  rates  that  enable  the  employer  of  such  labor  to  reap 
large  profits.  Women  employed  under  the  sweating  sys- 
tem, and,  to  a  less  extent,  women  employed  in  factories 
and  shops,  are  often  paid  less  than  their  labor  is  really 


ENTERPRISE   AND    BUSINESS    TROFITS  241 

worth,  according  to  competitive  standards.  In  the  history 
of  every  industrial  country,  instances  have  appeared  of 
large  profits  founded  upon  the  exploitation  of  child  labor. 

A  similar  exploitation  of  capital  sometimes  occurs.  Not 
many  years  ago,  in  some  of  our  states,  persons  intrusted 
with  public  funds  habitually  employed  such  funds  for 
their  own  advantage.  Such  a  course  of  action,  even 
when  not  unlawful,  was  generally  disapproved,  and 
hence  was  kept  secret,  so  far  as  possible.  Loans  of 
such  funds  were  made  at  rates  low  enough  to  pur- 
chase silence  from  the  borrower,  who,  accordingly,  was 
placed  in  a  position  where  he  could  make  large  profits. 
Trustees  having  little  interest  in  their  wards  have  been 
known  to  lend  the  funds  intrusted  to  them  at  abnormally 
low  rates.  Instances  of  this  kind  are  by  no  means  so  rare 
as  they  are  generally  supposed  to  be ;  but  recognition  of 
this  fact  must  not  lead  us  to  the  view  that  profits  are 
normally  the  result  of  conscienceless  exploitation. 

9.  Profits  may  arise  from  the  transportation  of  labor 
or  capital  from  regions  of  low  productivity  to  regions  of 
Jiigh  productivity,  under  contracts  in  ivhich  rctvards  arc 
based  upon  standards  prevailing  in  the  regions  of  loxv  prod- 
uctivity. 

Let  us  suppose  that  an  employer  of  large  numbers  of 
unskilled  laborers  in  the  United  States  sends  agents  to 
Europe,  or  even  to  the  Orient,  to  obtain  a  supply  of  labor. 
What  the  agent  will  offer  for,  say,  two  years'  labor  will  be 
the  local  rate  of  wages  for  that  period  of  time  together 
with  such  a  premium  as  may  be  necessary  to  overcome 
the  reluctance  of  laborers  to  leave  their  native  land.  The 
cost  of  labor  is  thus  determined  chiefly  by  the  standards 
of  productivity  prevailing  in  countries  from  which  the 
laborers  are  imported,  while  the  value  of  the  labor  to  the 
enterpriser  is  determined  by  American  conditions  of  prod- 
uctivity, which  are  admittedly  more  favorable.     By  virtue 


242 


INTRODUCTION   TO    ECONOMICS 


of  the  labor  contract  the  employer  is  thus  enabled  to  re- 
tain for  himself  a  part  of  the  product  of  the  labor. 

It  is  obvious  that  the  possibility  of  obtaining  a  profit  of 
this  nature  depends  in  large  measure  upon  the  character 
of  the  laws  relating  to  labor  contracts.  If  the  enterpriser 
cannot  enforce  the  contract  by  law  the  laborers  whom  he  has 
imported  may  desert  him  before  their  services  have  yielded 
adequate  compensation  for  the  cost  of  bringing  them  to 
the  country.  In  the  United  States  to-day,  not  only  would 
such  a  contract  be  unenforceable,  but  the  importation  of 
laborers  from  foreign  countries  under  such  contracts- is  a 
punishable  offense.  This  was  not  formerly  the  case,  and 
one  of  the  important  sources  of  profits  in  early  American  eco- 
nomic history  was  of  the  character  that  has  been  described. 
There  is  reason  to  believe  that  the  system  is  still  exten- 
sively employed  in  the  United  States.  The  importer  of 
contract  labor  relies  upon  the  ignorance  or  loyalty  of  the 
laborer  to  protect  him  from  loss  through  the  repudia- 
tion of  contracts.  In  many  parts  of  the  world,  especially 
in  the  tropics,  the  contract  labor  system  is  widely  used. 
There  are  companies  which  make  it  their  sole  business 
to  supply  enterprisers  with  contract  laborers  from  China 
and  India.  Such  companies  derive  their  profit  from  the 
product  of  the  laborers,  part  of  which  is  made  over  to  the 
company  by  the  enterpriser  who  employs  the  laborers. 

We  need  not  here  consider  the  reasons  that  have  led  to 
the  general  condemnation  of  enterprise  that  relies  for  its 
profits  on  contract  labor.  What  we  are  more  immediately 
concerned  with  is  the  possible  extent  of  profits  of  this  nature. 
Let  us  suppose  that  the  Chinese  coolie  in  his  own  home 
can  obtain  an  annual  wage  of  $50,  while  his  services  on  a 
Spanish-American  plantation  or  other  enterprise  are  worth 
$250  per  annum.  Allowing  $150  for  bringing  the  laborer 
from  China  and  for  his  return,  and  $50  a  year  to  overcome 
his  reluctance  to  leave  his  native  land,  there  would  remain, 


ENTERPRISE   AND    BUSINESS    PROFITS 


24i 


on  a  two-year  labor  contract,  a  ])rofit  of  $150  to  the  enter- 
priser, if  he  imports  the  labor  directly,  or  to  be  cli\'ided  be- 
tween the  enterpriser  and  the  coolie  labor  company,  if  the 
latter  acts  as  intermediary. 

We  may  apply  the  same  reasoning  to  the  case  of  profits 
arising  from  the  transfer  of  capital  from  regions  where  its 
productivity  is  low  to  regions  where  its  productivity  is 
relatively  high.  A  mortgage  loan  company  may  borrow 
capital  in  New  York  at  five  per  cent  interest  and  loan  it  in 
Texas  at  seven  per  cent.  The  loan  company  thus  receives 
a  profit  of  two  per  cent.  How  is  this  profit  produced.? 
Clearly  it  is  a  part  of  the  product  of  the  capital  set  at  work 
in  Texas. 

10.  Profits  may  arise  when  commodities  zu/iich  sell  at  prices 
covering  costs  in  high  wage-stamlard  regions  are  zvorked  np 
in  regio)is  having  a  low  zuage-standard. 

The  prices  charged  by  American  bookbinders  for  the 
binding  of  books  are  based  upon  the  cost  of  labor  in  this 
country,  which  exceeds  the  cost  of  equally  efficient  labor  in 
foreign  countries.  There  are  men  who  ship  books  from 
the  United  States  to  Paris  to  have  them  bound,  as  the  cost 
of  transportation  is  not  high  enough  to  equal  the  saving  in 
wages.  The  net  saving  represents  a  profit  to  the  enter- 
priser. There  are  metropolitan  publishing  houses  that 
have  printing  done  in  small  towns,  where  rates  of  wages  for 
printer's  labor  are  less  than  in  the  large  cities.  The  profits 
of  Southern  cotton  manufacturers  were  for  a  loner  time  de- 
pendent  upon  the  fact  that,  while  the  prices  they  received 
for  their  products  were  held  at  a  level  sufficient  to  cover 
costs  in  New  England,  the  wage  level  in  the  South  was 
lower  than  that  of  New  England.  Great  profits  were 
gained  by  Japanese  cotton  manufacturers  by  virtue  of  the 
fact  that  while  the  prices  of  cotton  goods  in  the  Orient  had 
to  be  sufficient  to  cover  the  high  labor  costs  in  America 
and  England,  efficient  labor  could  be  had  in  Japan  at  very 
low  wages. 


244  INTRODUCTION   TO   ECONOMICS 

Profits  may  also  arise  through  transferring  an  industr}) 
from  a  region  of  dear  coal  to  a  region  of  cheap  coal.  If  a 
commodity  is  expensive  to  transport,  profits  may  be  made 
by  removing  the  industry  producing  it  to  a  point  near  the 
centers  of  consumption  ;  if  the  materials  entering  into  the 
production  of  a  commodity  are  exceedingly  bulky,  profits 
may  be  made  by  removing  the  industry  to  points  near  the 
source  of  supply  of  materials.  With  changes  in  the  tech- 
nique of  transportation  and  in  charges  for  carrying  goods, 
there  are  changes  in  the  relative  advantages  of  different 
producing  centers ;  and  those  enterprisers  who  can  adapt 
themselves  quickly  to  these  changes  are  able .  to  gain 
profits. 

11.  Under  certain  business  conditions^  enterprisers  as  a 
class  may  reap  profits,  ozving  to  the  fact  that  the  rates  of 
wages  and  interest  are  s/ozv  to  change. 

In  times  of  business  prosperity  it  often  happens  that  the 
prices  of  almost  all  commodities  rise ;  or,  what  amounts  to 
the  same  thing,  the  products  of  labor  and  capital,  measured 
in  terms  of  price,  increase.  For  a  time  enterprisers  fear 
that  the  rise  in  prices  is  a  merely  temporary  phenomenon, 
to  be  followed,  perhaps,  by  a  fall  of  prices  to  a  level  lower 
than  that  existing  before  the  rise.  So  long  as  enterprisers 
maintain  this  attitude,  they  naturally  refrain  from  enlarg- 
ing their  businesses.  No  enterpriser  .attempts  to  entice 
away  the  workmen  in  the  employ  of  other  enterprisers,  as  he 
would  do  if  he  believed  that  the  high  level  of  prices  would 
be  maintained,  nor  does  he  increase  his  demands  upon  the 
fund  of  loanable  capital.  There  is  accordingly  no  reason 
why  wages  and  interest  should  rise.  The  effect  of  the  rise 
of  prices  is  thus  to  increase  the  price  of  the  products  of 
labor  and  capital  without  increasing  the  cost  of  labor  or  of 
the  use  of  capital.  If  before  the  rise  in  prices  labor  and 
capital  received  the  whole  value  of  their  products,  it  is  ob- 
vious that  they  receive  less  than  this  after  the  rise.     A  part 


ENTERPRISE   AND   BUSINESS   PROFITS  245 

of  the  product  of  labor  and  of  capital  remains  in  the  hands 
of  the  enterprisers  as  a  profit. 

12.  Profits  arc,  hi  most  instances,  a  temporary  form  of 
mcome. 

The  sources  of  profit  that  have  been  described  have  one 
characteristic  in  common  :  they  cannot  flow  for  a  very  long 
period  of  time.  An  importer  of  coolie  labor  may,  for  a 
time,  make  large  profits ;  but  if  he  does  so,  other  importers 
appear,  and  either  force  up  the  price  of  this  kind  of  labor 
at  its  source  or  depress  the  value  of  the  services  of  coolie 
labor  in  the  importing  country.  Sweat-shop  contractors 
may  for  a  time  make  large  profits  out  of  underpaid  labor ; 
but  in  the  end  the  number  of  contractors  increases,  and  this 
either  raises  the  wages  paid  to  this  kind  of  labor,  or,  what 
is  more  commonly  the  case,  reduces  the  prices  that  are 
paid  to  contractors.  Profits  depending  upon  local  cheap- 
ness of  labor  eventually  disappear  on  account  of  increase 
in  competition  for  such  labor  and  rise  in  its  price,  except 
in  cases  where  the  supply  of  such  labor  is  practically  un- 
Hmited,  as  in  the  Orient.  In  such  cases  the  industry  must 
eventually  develop  to  such  an  extent  as  to  create  a  large 
increase  in  the  product,  with  a  consequent  reduction  in  its 
price;  and  thus,  in  the  end,  a  level  of  prices  of  finished 
products  is  established  which  corresponds  with  the  lower 
cost  of  labor,  and  leaves  no  margin  for  profits.  If  profits 
depend  upon  superiority  of  methods,  these  methods,  in 
time,  are  universally  adopted,  and  prices  fall  accordingly. 
If  profits  depend  upon  industrial  misadjustments  that 
leave  some  industries  undersupplied  with  labor  and  capi- 
tal, they  are  eventually  eliminated  by  migration  of  labor 
and  capital  from  the  fields  that  are  oversupplied  to  those 
that  are  undersupplied.  The  general  profits  that  attend 
business  prosperity  are  wiped  out  by  readjustments  in  the 
prices  of  products  and  in  wages  and  interest. 

A  particular  enterpriser  may,  indeed,  obtain  a  continuous 


246  INTRODUCTION   TO    ECONOMICS 

income  from  profits.  When  he  finds  that  one  source  of 
profit  is  running  dry,  he  searches  out  another.  This  im- 
pHes  a  rapidly  developing  state  of  industry,  such  as  one 
finds  in  new  countries  like  the  United  States.  In  this 
country  it  is  not  difficult  to  find  instances  of  men  who  have 
enriched  themselves  now  from  one  source  of  profit,  now 
from  another. 

13.  Profits  dependent  upon  the  various  forms  of  monopoly 
may  display  a  high  degree  of  permanejice. 

One  of  the  most  important  sources  of  profit  is  the  intro- 
duction of  new  and  more  fruitful  methods  of  production. 
So  long  as  such  a  method  is  confined  to  one  out  of  a  number 
of  competing  establishments,  prices  remain  at  a  level  which 
covers  cost  of  production  in  the  establishments  which  do 
not  employ  the  new  method.  If  the  new  method  of  pro- 
duction is  really  an  innovation  in  industry,  and  if  it  is  of 
such  a  nature  as  to  admit  of  definite  description  —  as,  for 
example,  a -mechanical  device  for  saving  labor  —  the  per- 
son who  invented  it  may  take  out  a  patent,  which  will  as- 
sure to  him  the  exclusive  right  of  using  it  for  a  period  of 
time  —  seventeen  years,  in  the  United  States.  During 
this  period  he  may  continue  to  enjoy  the  profits  arising 
from  the  use  of  the  method.  He  may,  of  course,  sell  the 
right  of  use  to  other  persons,  in  which  case  he  makes  labor 
and  capital  more  productive  in  the  establishments  buying 
the  right,  reserving  for  himself,  in  the  shape  of  payments 
for  the  use  of  the  patent,  a  part  of  the  product  of  these 
agents  of  production. 

Somewhat  analogous  to  the  profits  arising  from  a  patent 
are  the  profits  arising  from  the  use  of  a  trade-mark  or 
from  the  "  good-will "  of  a  concern,  A  certain  brand  of 
soap  has,  let  us  say,  a  reputation  for  purity,  established  by 
long  years  of  honest  business.  Another  soap  bearing  an- 
other name  may  be  just  as  pure  ;  but  the  consumer  has  no 
adequate  means  of    determining    qualities,   and    therefore 


ENTERPRISE   AND    BUSINESS    PROFITS  247 

prefers  the  brand  which  he  has  always  believed  to  be  good. 
It  is  evident  that  the  manufacturers  enjoying  such  a  firm 
hold  on  the  popular  favor  can  charge  somewhat  higher 
prices  for  goods  of  a  given  grade  than  can  manufacturers 
who  have  their  reputation  yet  to  establish.  So  a  merchant 
who  has  established  a  reputation  for  upright  dealing,  or 
who  has  succeeded  in  attracting  to  himself  the  patronage 
of  the  wealthier  classes  of  a  city,  can  charge  somewhat 
more  than  can  his  less  fortunate  competitors.  The  public 
esteem  which  an  enterpriser  enjoys  —  the  good-will  of  the 
business — is  sometimes  only  an  insignificant  source  of 
profits.  Sometimes,  however,  it  is  an  exceedingly  impor- 
tant source.  In  many  cases  the  good-will  of  a  manufac- 
turing or  mercantile  establishment  is  worth  more  than  its 
aggregate  tangible  assets. 

The  profits  arising  from  patented  processes  and  from 
the  good-will  of  an  establishment  fall  under  the  general 
head  of  monopoly  profits.  The  surplus  returns  to  an  ordi- 
nary monopoly  may  be  described  in  the  same  way.  Let  us 
suppose  that  all  the  manufacturers  of  tin  plate  agree  to  re- 
duce output  twenty  per  cent  in  order  to  force  up  prices. 
If  the  various  producers  can  be  held  to  their  agreements, 
and  if  new  producers  can  be  kept  from  entering  the  field, 
there  is  no  reason  why  every  enterpriser  in  the  business 
should  not  enjoy  a  permanent  profit.  In  the  chapter  on 
monopoly  price  we  saw  how  this  can  be  done.  What  the 
monopolists  do,  from  the  point  of  view  of  distribution,  is 
this  :  A  group  of  allied  enterprisers  throw  a  fence,  as  it 
were,  around  a  particular  field  of  industry.  They  limit 
the  amount  of  labor  and  capital  admitted  to  the  field,  so 
that  the  productivity  of  these  agents  remains  higher  than  in 
the  unmono])olized  fields.  The  wages  and  interest  paid  by 
the  monopoly  are  no  higher  than  wages  and  interest  in  the 
unmonopolized  fields.  Consequently,  there  remains  in  the 
hands  of  the  monopolistic  enterprisers  a  surplus  or  profit. 


248  INTRODUCTION   TO   ECONOMICS 

14.  Monopoly  profits  may  be  capitalized  in  tlie  same  way 
as  other  permanent  incomes  frotn  property. 

We  saw  in  the  last  chapter  how  it  is  possible  to  arrive 
at  the  value  of  a  capital  good,  such  as  a  field,  by  capitalizing 
the  income  at  the  current  rate  of  interest.  Permanent 
profits  may  be  reduced  to  a  capital  value  in  the  same  way. 
If  the  profit  from  a  monopoly  is  $100,000  a  year,  and  if 
there  is  good  reason  for  believing  that  it  will  continue  to 
be  the  same  from  year  to  year,  the  monopoly  itself  is 
worth  as  much  as  a  sum  of  capital  that  will  yield  $100,000 
interest  per  annum.  If  capital  generally  yields  five  per 
cent,  the  monopoly  is  worth  $2,000,000.  If  the  enterprisers 
having  such  a  monopoly  were  to  sell  out  their  interests, 
they  would  demand  that  sum  over  and  above  full  payment 
for  all  the  buildings,  machinery,  and  other  tangible  assets 
of  their  business.  The  same  thing  is  true  of  the  profits 
arising  from  the  good-will  of  a  business.  These  profits  will 
be  capitalized,  and  the  buyer  of  the  business  will  have  to 
add  the  capital  value  of  the  profits  to  the  value  of  the 
tangible  capital  goods. 

The  value  of  a  patent  is  found  in  a  similar  manner. 
The  only  difference  is  that  the  profits  from  this  source 
cease  upon  the  expiry  of  the  patent.  What  the  buyer 
pays  for  is  the  right  to  a  certain  estimated  income  for  a 
definite  number  of  years.  If  the  annual  income  is  esti- 
mated at  $5000  a  year,  and  the  patent  has  ten  years  to 
run,  the  simplest  way  of  arriving  at  the  value  of  the  patent 
is  to  find  the  present  value  of  "each  year's  income,  and  add 
these  sums  together.  If  the  current  rate  of  interest  is  four 
per  cent,  the  present  value  of  $5000  due  in  one  year  is  ob- 
viously equal  to  a  sum  which,  plus  interest  for  a  year,  will 
amount  to  $5000.  That  sum  is  about  $4807.  $5000  to 
fall  due  two  years  hence  is  worth  a  present  sum  which  to- 
gether with  compound  interest  at  four  per  cent  will  in  two 
years  amount   to    $5000 — $4625,     By  a  similar   process 


ENTERPRISE    AND    BUSINESS    PROFITS 


?49 


—  known  as  discounting  —  the  value  of  each  year's  income 
may  be  ascertained,  and  by  addition,  the  present  value  of 
the  patent  is  established. 

15.  Profits  usually  phxy  an  important  part  in  promoting 
economic  progress  and  in  directing  the  distribution  of  the 
productive  resoiures  of  society. 

All  profits,  whether  monopolistic  or  not,  are,  from  the 
point  of  view  of  distribution,  a  part  of  the  product  of  labor 
and  capital  which  various  circumstances  enable  the  enter- 
priser to  retain  for  himself.  It  may  therefore  appear,  at 
first  thought,  that  the  existence  of  profits  is  evidence  of  in- 
justice in  the  distribution  of  wealth. 

Upon  reflection,  however,  we  see  that  this  is  not  true. 
Profit  in  many  cases  plays  an  important  part  in  stimulating 
economic  progress ;  in  many  other  cases  the  existence  of 
profit  serves  as  a  means  of  distributing  the  agents  of  pro- 
duction in  such  a  way  as  best  subserves  the  interests  of 
society.  An  income  that  must  exist  if  society  is  to  be  pro- 
gressive and  if  the  best  disposition  is  to  be  made  of  its  pro- 
ductive resources  can  hardly  be  regarded  as  unjustifiable. 

It  is  the  hope  of  profits  that  induces  the  enterpriser  to 
devise  improved  methods  of  production,  or  to  adopt  im- 
provements devised  by  others.  In  doing  this  the  enterpriser 
increases  the  productivity  of  labor  and  capital,  reserving 
for  himself,  as  long  as  he  can,  the  benefits  of  this  increased 
productivity.  But  sooner  or  later  the  new  method  finds 
general  application  in  the  industry,  and  the  enterprisers  are 
forced  to  yield  up  the  benefits  arising  from  it  to  labor  and 
capital,  in  the  form  of  increased  wages  and  interest,  or  to 
the  consumer  of  commodities  in  the  form  of  lower  prices. 
In  the  latter  case  all  laborers  and  capitalists  gain  by  an  in- 
crease in  the  purchasing  power  of  their  incomes. 

When  profits  arise  from  a  general  increase  in  the  de- 
mand for  a  commodity,  the  ethical  title  of  the  enterpriser 
to  the  income  is  perhaps  not  quite  so  clear.      But  such  an 


250  INTRODUCTION  TO   ECONOMICS 

increase  in  demand  shows  that  the  amount  of  labor  and 
capital  devoted  to  the  industry  affected  by  the  increased 
demand  should  be  increased.  Under  the  competitive  sys- 
tem this  result  can  be  brought  about  only  through  the 
action  of  enterprisers.  Now,  if  enterprisers  received  no 
profit  from  enlarging  old  works  and  establishing  new  ones, 
why  should  they  trouble  themselves  with  doing  this?  If, 
on  the  other  hand,  they  may  for  a  time  keep  for  themselves 
as  a  profit  a  part  of  the  price  of  their  products,  they  will 
naturally  endeavor  to  enlarge  their  works  as  quickly  as 
possible.  When  at  last  as  much  labor  and  capital  is  de- 
voted to  the  industry  as  is  socially  expedient,  profits  cease 
through  rise  in  wages  and  interest  or  through  fall  in  prices. 

Of  the  forms  of  profit  that  are  classed  as  monopolistic, 
those  arising  from  patented  inventions  and  from  good-will 
need  no  defense.  The  former  is  the  reward  for  one  of  the 
most  important  services  to  society.  The  inventor  can 
never  get  for  his  services,  at  any  time,  more  than  they 
are  worth  to  society  ;  at  the  expiry  of  the  patent  the  inven- 
tion becomes  the  common  possession  of  all.  The  profits 
arising  from  good-will,  in  the  literal  sense  of  the  term,  are 
a  reward  for  honorable  business  dealing,  and  can  be  re- 
tained only  so  long  as  the  enterpriser  is  worthy  of  them. 

16.  TJie  profits  of  cm  ordinary  monopoly  cannot  be  ethic- 
ally justified. 

The  profits  of  an  ordinary  monopoly,  so  far  as  they  are 
true  monopoly  profits,  stand  on  an  entirely  different  footings 
The  productivitv  of  labor  and  capital  in  the  field  controlled 
by  the  monopoly  is  rendered  abnormally  high,  not  merely 
through  superior  organization  and  combination  of  these 
factors  in  production,  but  largely  through  the  maintenance 
of  an  artificial  scarcity  of  them,  which  is  directly  opposed 
to  the  interests  of  society.  While  the  action  of  any  one 
out  of  a  number  of  competing  enterprisers,  each  striving 
to  increase  his  own  profit,  usually  operates  to  increase  the 


ENTERPRISE   AND   BUSINESS   PROFITS  251 

aggregate  wealth  produced  by  society,  the  action  of  a  com 
bination  of  enterprisers  striving  to  secure  a  monopoly 
profit  operates  to  reduce  the  aggregate  wealth  })r()duction 
of  society.  Through  his  anti-social  conduct  the  monoi)olis- 
tic  enterpriser  receives  a  permanent  profit,  the  fruits  of  other 
men's  labor  and  capital.  The  enterpriser  who  carries  on 
business  under  conditions  of  competition  receives,  as  a  re- 
ward for  his  important  services  to  society,  only  a  temporary 
profit. 

It  appears,  therefore,  that  the  elimination  of  monopoly 
profit  through  legislative  action,  if  possible,  is  eminently  de- 
sirable. It  is,  however,  to  be  borne  in  mind  that  this  can- 
not always  be  done  without  injustice.  We  have  seen  that 
monopoly  profit,  being  permanent,  maybe  capitalized.  If 
a  combination  of  manufacturing  enterprises  makes  possible 
a  monopoly  profit  of  $100,000,  the  selling  value  of  the  com- 
bined enterprise  —  or  of  the  capital  stock  representing  it  — 
is  increased  by  the  capital  value  of  an  income  of  $100,000. 
Now,  the  original  promoters  of  the  monopoly  do  not  con- 
tinue to  own  it  forever.  Some  of  the  stock  in  it  may  pass 
to  their  heirs  ;  some  of  it  may  be  sold  to  persons  who  do  not 
know  that  a  great  part  of  its  value  is  merely  the  capitaliza-' 
tion  of  a  wrongful  monopoly  profit.  If,  then,  the  profit  of 
the  monopoly  is  eliminated,  the  latter  class  of  persons  find 
themselves  deprived  of  an  income  the  right  to  which  they 
purchased  in  good  faith  as  an  income  from  capital. 

17.    Sumnmry. 

In  a  progressive  society  exceptional  opportunities  for 
the  employment  of  labor  and  capital  are  continually  pre- 
senting themselves.  The  act  of  seizing  upon  such  oppor- 
tunities is  known  as  enterprise  ;  the  income  arising  from 
enterprise  is  pure  profit.  The  existence  of  profitable  op- 
portunities is  evidence  of  the  fact  that  competition  does 
not  operate  freely. 

From  the  point  of  view  of  distribution  profit  is  an  income 


252 


INTRODUCTION   TO    ECONOMICS 


created  by  labor  and  capital,  but  retained  by  the  enterpriser. 
When  labor  and  capital  are  abnormally  productive,  but  are 
paid  at  normal  rates,  a  surplus  remains  for  profit ;  when 
labor  and  capital  are  normally  productive,  but  are  paid  at 
abnormally  low  rates,  a  similar  surplus  appears.  The  im- 
portation of  labor  and  capital  from  regions  of  low  produc- 
tivity to  regions  of  high  productivity,  with  the  maintenance, 
in  the  latter  regions,  of  the  standards  of  pay  established  in 
the  former  regions,  is  one  source  of  profit ;  the  transfer  of 
an  industry  from  a  region  in  which  standards  of  pay  are 
high  to  a  region  where  such  standards  are  low  is  another 
source  of  profit. 

As  a  rule,  profit  is  a  temporary  form  of  income.  Mo- 
nopoly, in  its  various  forms,  gives  to  profit  a  fair  degree  of 
permanence.  Monopoly  profit  is  therefore  capitalized  like 
any  other  form  of  permanent  income. 

Since  profit  is  an  income  produced  by  the  labor  and  capi- 
tal of  one  set  of  men  and  enjoyed  by  another  set  of  men, 
it  appears  to  demand  an  ethical  justification.  Competitive 
profits  may  be  defended  on  the  ground  that  they  serve  as 
an  incentive  to  improvement,  and  help  to  adjust  the  supply 
of  each  commodity  to  the  demand  for  it.  Such  forms  of 
monopoly  profit  as  the  royalties  of  an  inventor  and  the 
receipts  from  the  good-will  of  a  business  are  easily  de- 
fended. The  profits  of  an  ordinary  monopoly  cannot  be 
defended,  ethically  ;  their  continued  existence  depends 
upon  the  preservation  of  a  misadjustment  of  demand  and 
supply. 


CHAPTER   XV 

MONEY 

1.  Motley  is  anything  that  practically  all  men  are  ready 
to  accept  in  exchange  fort  Juir  goods,  ivith  the  expectation  of 
employing  it  in  the  acquisition  of  other  goods. 

In  the  foregoing  chapters  frequent  use  has  been  made 
of  the  concept  price,  which  of  course  implies  the  concept 
money,  since  price  is  nothing  but  exchange  value,  expressed 
in  terms  of  money.  It  has  been  tacitly  assumed  that  money 
is  in  general  use  and  that  its  value  remains  constant,  price 
fluctuations  being  due  to  changes  in  the  conditions  of  pro- 
duction or  consumption  of  other  things.  The  latter  assump- 
tion, as  every  one  familiar  with  recentdiscussionsof  economic 
policy  is  aware,  cannot  pass  unchallenged.  The  value  of 
money,  like  the  value  of  all  other  things,  is  subject  to  con- 
tinual fluctuations,  and  these  fluctuations  give  rise  to  some 
of  the  most  important  problems  of  practical  economics. 

We  may  profitably  begin  this  part  of  our  study  by  con- 
sidering what  it  is  that  the  plain  man  regards  as  money. 
Anything  that  is  accepted  by  practically  every  one  in  ex- 
change for  his  goods  or  services,  with  the  sole  intention  of 
exchanging  it  ultimately  for  other  goods  or  services,  is 
popularly  regarded  as  money.  This  view,  which  is  also 
that  of  many  of  the  ablest  writers  on  money,  we  may  safely 
adopt  as  our  own.  Under  different  conditions  of  economic 
development,  different  concrete  things  have  served  as  money, 
—  shells,  beads  and  other  ornaments,  bits  of  metal  coined 
or  uncoined,  and  even  such  commodities  as  cattle  and  furs. 
With  the  evolution  of  trade,  a  corresponding  evolution  of 
money  has  taken  place,  and  those  forms  of  money  which 
were  fitted  for  use  when  trade  was  merely  an  incidental 

253 


254  INTRODUCTION  TO   ECONOMICS 

part  of  economic  life  have  given  way  to  forms  of  money 
adapted  to  a  complex  system  of  commerce. 

2.  TJic  origin  of  money  is  to  be  sought  in  a  gradual  and 
unconscious  evolution  in  zvhich  certain  articles  of  direct  use 
came  to  be  more  and  more  frequently  accepted  in  exchange 
merely  as  a  meajts  of  acquiring  other  articles  of  direct  use. 

The  origin  of  money  antedates  all  historical  records. 
Nevertheless,  we  know  enough  about  the  life  of  primitive 
man  to  construct  a  plausible  view  of  the  circumstances 
under  which  money  must  have  come  into  existence.  In 
the  earlier  stages  of  human  evolution  exchange,  at  least  in 
the  modern  sense  of  the  term,  was  unknown ;  hence,  of 
course,  money  could  not  have  existed.  When  it  first  be- 
came customary  to  make  exchanges,  goods  were  doubtless 
bartered  directly  for  goods,  as  is  sometimes  the  case  even 
to-day.  Certain  articles,  however,  were  more  frequently 
the  objects  of  exchange  than  others,  as,  for  example, 
strings  of  seashells,  articles  of  copper,  silver,  and  gold 
suitable  for  personal  adornment.  Such  articles,  unlike  the 
common  necessaries  of  existence,  could  not  be  produced 
by  any  one  desiring  them.  Not  being  essential  to  life, 
they  would  naturally  be  sacrificed  by  their  possessors  in 
time  of  need.  The  desire  for  such  articles,  on  the  other 
hand,  could  not  be  easily  satiated.  We  can  easily  see, 
therefore,  wh}?-  articles  of  this  nature  should  have  been 
among  the  earliest  to  be  freely  purchased  and  sold.  We 
can  also  see  why  persons  having  ordinary  commodities  to 
dispose  of  should  have  been  willing  to  accept  such  articles 
with  at  least  a  half-intention  of  exchanging  them  later  for 
other  commodities.  Men  desiring  such  articles,  and  will- 
ing to  make  sacrifices  to  obtain  them,  could  easily  be 
found. 

Just  at  what  point  articles  of  personal  adornment,  as, 
for  example,  silver  bracelets,  ceased  to  be  ordinary  com- 
modities and  became  money  it  would  of  course  be  impossi- 


MONEY  255 

ble  to  say.  Some  men  may  liave  accepted  them  solely 
with  a  view  to  a  further  exchange.  Some  may  have  ac- 
cepted them  primarily  with  a  view  to  further  exchange, 
yet  with  the  alternative  of  personal  use  before  them  ;  still 
others  may  have  accepted  them  with  no  intention  of  ex- 
changing them  for  something  else.  To  the  first  class  of 
persons,  the  bracelets  would  have  been  money ;  to  the 
second,  neither  money  nor  ordinary  commodities  but  some- 
thing half  way  between ;  to  the  last  class  they  would  have 
been  merely  ordinary  commodities.  If  the  last  two  classes 
were  relatively  insignificant,  the  bracelets  would  properly 
have  been  called  money.  We  do  not  hesitate  to  call 
nickels  and  dimes  money,  although  certain  of  the  aborigi- 
nal inhabitants  of  the  United  States  perforate  all  they  can 
obtain  and  hang  them  in  strings  from  their  ears. 

3.  The  functions  of  money  are  ( i )  t/iat  of  medium  of  ex- 
change ;  (2)  that  of  store  of  piireJiasing  pozver ;  (3)  that  oj 
measure  of  value ;  and  (4)  that  of  standard  of  deferred 
payments. 

When  a  farmer  exchanges  a  load  of  wheat  for  money, 
and  immediately  exchanges  the  money  for  household  sup- 
plies, the  money  so  far  as  he  is  concerned  serves  merely 
as  means  for  exchanging  the  wheat  for  household  supplies. 
If  the  farmer  does  not  immediately  purchase  the  supplies, 
but  keeps  the  money  in  his  strong  box  against  future 
needs,  we  may  say  that  the  money  serves  as  a  convenient 
means  of  keeping  the  purchasing  power  originally  repre- 
sented by  the  wheat  through  a  period  of  time,  or  as  a  store 
of  purchasing  power.  If  the  local  dealer  is  at  once  a 
grain  buyer  and  a  dealer  in  household  suppHes,  no  money 
may  actually  be  used  in  effecting  the  exchange.  The 
value  of  the  grain  is  estimated  in  terms  of  money,  as  is 
also  the  value  of  the  household  supplies,  and  the  one  quan- 
tity of  money  value  is  set  against  the  other.  In  this  case 
money  is  used  solely  as  a  measure  of  value.     If  the  farmer 


256  INTRODUCTION   TO   ECONOMICS 

delivers  his  wheat,  but  "  trusts  "  the  dealer  with  its  valuei 
the  future  obHgation  of  the  dealer  to  the  farmer  is  reduced 
to  deiiniteness  in  terms  of  money.  The  farmer  is  credited, 
not  with  forty  bushels  of  wheat,  but,  we  will  say,  with  $35. 
In  this  way  money  serves  as  a  "standard  of  deferred 
payments." 

The  primary  function  of  money  is  that  of  medium  of 
exchange,  and  from  it  are  derived  the  other  three  functions. 
Money  serves  as  a  store  of  purchasing  power  because  of 
its  universal  acceptability  in  exchange.  It  serves  as  a 
measure  of  value  because  men  are  constantly  weighing 
the  value  of  other  things  against  that  of  money.  And 
for  the  same  reason  it  serves  as  a  standard  of  deferred 
payments.  If  you  promise  to  deliver  to  me  one  thousand 
bushels  of  wheat  a  year  hence,  I  have  no  very  definite 
idea  as  to  the  sum  of  value  I  am  to  receive.  If  you  prorh- 
ise  to  deliver  to  me  ^1000  a  year  hence,  I  have  a  definite 
idea  as  to  the  sum. 

4.  AnytJiing  serving  as  money  should  present  in  a  Jiigh 
degree  the  qualities  of  nnifonnity,  stability  of  value,  and 
adaptability  to  transactions  of  varying  magnitude. 

In  the  early  modern  commercial  centers  traders  were 
always  seriously  handicapped  by  the  great  variety  of  coins 
used  as  money.  In  every  business  transaction  it  was 
necessary  to  examine  the  money  offered  in  payment  almost 
as  carefully  as  the  quality  of  the  articles  offered  for  sale. 
In  many  cases  gold  and  silver  coins  passed  by  weight ; 
but  even  in  such  cases  there  was  always  some  question 
as  to  the  real  value  of  the  money,  as  the  coins  of  different 
countries  were  of  different  degrees  of  fineness.  It  is  ■ 
difficult  to  appreciate  the  advantages  presented  by  a 
monetary  system  Hke  that  of  the  United  States  of  to-day, 
in  which  one  dollar  represents  the  same  value  as  any  other. 

Hardly  less  important  than  uniformity  is  stability  of 
value.      If  money  is  to  serve  as  a  store  of  purchasing  power, 


MONEY  257 

its  value  must  not  be  subject  to  rapid  fluctuations.  If  it  is 
to  serve  as  a  standard  of  deferred  payments,  stability  of 
value  is  of  extreme  importance.  Imagine  the  inconvenience 
of  a  standard  fluctuating  in  value  as  widely  as  do  most  of 
the  commodities  of  common  use.  A  man  borrowing  money 
for  a  six  months  period  might  find  himself,  at  the  end  of 
the  period,  compelled  to  pay  back  twice  as  great  a  sum  of 
value  as  he  borrowed ;  or  he  might  escape  with  paying 
half  as  great  a  sum.  With  such  a  fluctuating  standard  all 
contracts  involving  future  payments  of  money  would  be- 
come highly  speculative. 

For  an  advanced  commercial  nation,  adaptability  of 
money  forms  to  transactions  of  varying  magnitude  is  of 
great  importance.  In  the  rural  districts  of  China,  where 
trade  is  chiefly  local  and  the  articles  of  trade  of  low  value, 
coins  of  one  kind,  and  these  of  very  low  value,  meet  practi- 
cally all  needs.  In  a  country  like  our  own,  with  the  greatest 
variety  of  business  transactions  to  be  performed  through 
the  medium  of  money,  a  wide  variety  of  forms  of  money  is 
required.  For  the  smallest  transactions  it  is  necessary  to 
have  coins  of  a  value  which  is  low,  relatively  to  bulk,  as 
bronze  cents,  nickel  five-cent  pieces.  For  slightly  larger 
transactions,  coins  of  silver,  which  represent  a  greater 
value  per  unit  of  bulk,  are  more  convenient.  For  transac- 
tions involving  still  greater  values,  gold  coins  are  better 
adapted  than  silver ;  for  the  largest  cash  payments,  paper 
money,  which  may  be  of  any  denomination,  is  the  most 
convenient  of  all.  How  important  is  this  variety  in  forms  of 
money  will  be  understood  by  any  one  who  happens  to  be 
engaged  in  business  in  a  town  where  at  times  the  supply 
of  small  coins  is  not  sufficient  to  meet  the  needs  of  petty 
trade,  or  in  a  section  where  silver  coins  are  employed  to  the 
exclusion  of  paper  in  all  transactions  involving  $10  or  less. 

5.    Unifonnity  in  the  diccUhdi  of  cxcJia)igc  depends  upon 
effective  governmental  regulation. 


258  INTRODUCTION  TO   ECONOMICS 

From  very  early  times  it  has  been  recognized  that  the 
coinage  of  money  is  a  business  of  such  great  public  im- 
portance that  it  cannot  be  left  to  unregulated  private 
enterprise.  The  private  coinage  of  gold  and  silver  has 
indeed  sometimes  been  tolerated.  In  the  United  States  as 
late  as  i860  privately  coined  gold  was  to  be  found  in  cir- 
culation. But  experience  showed  then,  as  it  had  often 
shown  in  earlier  periods  of  the  world's  history,  that  private 
coinage  results  in  serious  evils.  Coins  that  circulated  as 
of  equal  value  differed  as  much  as  ten  per  cent  in  their 
gold  content.  Those  who  were  least  able  to  judge  the 
probable  value  of  such  privately  issued  coins  were  hkely 
to  be  cheated  in  trade  with  those  who  were  better  able  to 
judge  the  value  of  these  coins.  Because  of  such  evils  the 
issue  of  coins  by  private  individuals  has  been  prohibited 
by  law.  All  coins  are  issued  directly  by  government,  and 
measures  are  taken  by  every  well-regulated  state  to  insure 
uniformity  of  value  of  money  thus  issued. 

6.  The  function  of  government  in  issuing  money  may  be 
(i)  to  stamp  tJie  weight  and  fineness  of  metal  iji  a  coin  ;  or 
(2)  in  a  restricted  sense,  to  determine  the  value  of  money 
regardless  of  the  value  of  the  material  composing  it. 

The  government  may  hold  its  mints  open  to  private 
owners  of  precious  metal,  coining  on  their  account  all  the 
metal  they  offer  for  coinage.  Thus  any  holder  of  gold 
bullion  can  take  it  to  the  United  States  mints  and  have  it 
made  into  coins.  In  such  case  it  cannot  be  said  that  the 
government  determines  the  value  of  the  coins  issued.  If 
there  is  a  large  production  of  gold,  there  is  likely  to  be  an 
increase  in  the  amount  of  gold  taken  to  the  mints  for 
coinage,  and,  as  we  shall  see  later,  a  tendency  toward  a 
decline  in  the  value  of  the  coins.  The  government  assures 
the  recipient  of  a  gold  coin  that  it  contains  the  requisite 
amount  of  pure  gold ;  practically  it  assures  him  of  nothing 
more. 


MOi\E:Y  259 

When  a  metal  is  freely  coined  on  individual  account, 
there  can  be  no  perceptible  difference  in  value  between  a 
siven  amount  of  the  metal  in  the  form  of  coin  and  an 
equal  amount  in  the  form  of  bullion.  In  the  United  States 
an  ounce  of  uncoined  gold  is  worth  just  as  much  as  an 
ounce  of  gold  coined.  If  for  any  reason  gold  in  the  form 
of  coins  should  become  more  valuable  than  gold  in  the 
form  of  bullion,  more  bullion  would  be  taken  to  the  mints, 
until  the  difference  in  value  disappeared.  If  uncoined 
gold  became  more  valuable  than  gold  in 'coins,  coins  would 
be  melted  down,  until  again  the  difference  disappeared. 

A  government  may  accept  for  coinage  on  individual  ac- 
count either  gold  or  silver,  or  both  metals.  When  gold 
alone  is  freely  coined  on  individual  account,  the  monetary 
system  of  a  country  is  said  to  be  based  upon  gold  monojnet- 
allism.  When  both  gold  and  silver  are  freely  accepted  for 
coinage,  the  monetary  system  is  based  upon  bimetallism. 
The  bimetallic  system  was  generally  employed  in  modern 
times  until  the  nineteenth  century.  Early  in  that  century 
Great  Britain  adopted  gold  monometallism,  and  in  the  latter 
part  of  the  century  the  same  system  was  adopted  by  all 
other  important  commercial  nations. 

When  a  monetary  system  is  based  upon  gold  freely 
coined  by  government  on  individual  account,  the  needs  of 
trade  require  the  presence  of  money  composed  of  other 
materials,  such  as  silver,  nickel,  bronze,  and  sometimes 
paper.  The  value  of  such  forms  of  money  is  said  to  be 
determined  by  government,  since  it  bears  no  fixed  relation 
to  that  of  the  material  from  which  it  is  made,  as  is  the 
case  with  the  money  made  from  a  metal  freely  coined. 
As  a  fact,  the  government  issuing  such  money  usually 
adopts  measures  designed  to  maintain  a  fixed  relation  be- 
tween the  value  of  such  money  and  that  of  gold.  The  gov- 
ernment of  the  United  States  regulates  its  currency  in 
such  a  way  that  a  five-dollar  bill,  or  five  silver  dollars,  or 


26o  INTRODUCTION   TO   ECONOMICS 

five  hundred  bronze  cents  are  always  equal  in  value  to  a 
five-dollar  gold  piece.  Gold  coin,  which  serves  as  a  stand- 
ard, may  rise  or  fall  in  value ;  all  other  forms  of  money 
rise  or  fall  with  it.  All  the  non-standard  forms  of  money 
are  said  to  be  maintained  at  a  parity  with  the  standard 
form.  ' 

7.  TJie  only  practical  zvay  of  maintaining  all  the  forms  of 
money  at  a  parity  is  through  provision  for  the  exchange  of 
any  form  for  the  others  at  the  option  of  the  holder. 

If  a  government  issues  a  limited  amount  of  paper  money 
and  makes  it  legal  tender,  that  is,  receivable  at  its  face 
value  in  payment  of  all  debts,  public  and  private,  such 
money  may  circulate  at  par,  with  no  further  provision  for 
regulating  its  value.  If  I  am  offered  a  piece  of  paper 
which  I  am  certain  will  be  equivalent  to  $io  in  gold  in  the 
payment  of  taxes,  or  in  the  payment  of  my  debts  to  other 
persons,  there  is  no  reason  why  I  should  not  accept  it  as 
readily  as  $io  in  gold. 

If  much  of  this  kind  of  money  is  issued,  however,  every 
one  may  hesitate  to  accept  it  in  lieu  of  gold.  Dealers  may 
refuse  to  accept  it  in  e.xchange  for  their  goods ;  accordingly, 
it  may  depreciate  in  value  in  spite  of  the  fact  that  it  is  re- 
ceivable at  par  in  payment  of  public  dues  and  existing 
debts. 

To  make  certain  that  non-standard  forms  of  money  shall 
not  fall  below  their  face  value  in  gold,  it  is  customary  for 
governments  to  make  provision  for  redeeming  them  in  gold 
on  demand.  In  the  monetary  system  of  the  United  States 
are  to  be  found  coins  of  gold,  silver,  nickel,  and  bronze,  as 
well  as  paper  money.  Part  of  the  paper  money  consists  of 
gold  and  silver  certificates  ;  a  small  part  of  it,  of  treasury 
notes,  issued  in  payment  for  silver  bullion;  part  of  it  of 
"greenbacks"  —  promissory  notes  of  the  government,  a  leg- 
acy of  the  Civil  War.  All  these  forms  of  money  are  main- 
tained at  an  absolute  parity  by  the  government.     The  gold 


MONEY  261 

certificates  cannot  fall  below  the  value  of  gold  coin,  because 
for  every  dollar  of  such  certificates  there  is  a  dollar's  worth 
of  gold  coin  or  bullion  in  the  United  States  Treasury,  payable 
to  the  certificate  holder  on  demand.  The  silver  certificates 
are  likewise  secured  in  value  by  treasury  holdings  of  silver. 
It  is  a  part  of  the  settled  policy  of  the  United  States  to 
maintain  the  silver  dollars  at  a  parity  with  gold ;  and 
although  no  specific  provision  is  made  by  law  for  the  ex- 
change of  silver  dollars  for  gold  at  the  treasury,  the  privi- 
lege of  making  such  an  exchange  would  doubtless  be  ac- 
corded the  holder  of  silver  dollars  if  the  latter  showed  any 
tendency  to  depreciate.  A  reserve  of  $150,000,000  in  gold 
is  held  by  the  treasury  for  the  purpose  of  redeeming  any 
greenbacks  that  may  be  presented  for  redemption.  Any 
one  who  desires  may  exchange  the  lesser  silver,  nickel,  and 
copper  coins  for  gold  by  presenting  them  in  suitable  quan- 
tities at  the  treasury. 

^.  If  a  government  fai/s  to  maintain  all  its  forms  of 
money  at  a  parity,  those  forms  tJiat  become  depreciated  tend 
to  drive  those  that  are  not  depreciated  from  circiihition. 
TJiis  principle  is  knotvn  as  GresJiani  s  law. 

Let  us  suppose  that  the  government  of  the  United 
States  issues  a  large  volume  of  paper  money,  and  makes 
no  adequate  provision  for  exchanging  gold  for  such  paper 
at  the  option  of  the  holder.  The  value  of  such  money 
would  be  very  likely  to  depreciate,  in  terms  of  gold.  After 
depreciation,  every  person  who  has  payments  to  make 
in  which  the  form  of  money  is  not  specified,  naturally 
uses  whatever  paper  money  he  has  in  his  possession, 
and  retains  his  gold.  If  he  has  nothing  but  gold 
in  the  first  instance,  he  exchanges  it  for  paper,  since 
he  can  get  more  than  $100  in  paper  for  $100  in  gold, 
and  then  makes  his  payments  in  paper  money.  Thus 
gold  ceases  to  pass  freely  from  hand  to  hand;  if  it  is 
used  at  all,  it  is  as  a  commodity,  valued  in  terms  of  paper 


262  INTRODUCTION  TO   ECONOMICS 

money.  Thus  the  paper  money  issued  by  the  United 
States  in  the  time  of  the  Civil  War  expelled  gold  and  silver 
from  circulation.  When  gold  and  silver  are  both  freely 
coined  it  is  usually  impracticable  for  a  government  to 
maintain  the  two  forms  of  money  at  an  absolute  parity. 
At  one  time  an  ounce  of  gold  may  be  worth  sixteen  ounces 
of  silver ;  if  then  silver  and  gold  are  coined  at  a  ratio  of 
sixteen  to  one,  —  that  is,  if  a  dollar  in  silver  contains  sixteen 
times  as  much  pure  metal  as  a  dollar  of  gold,  — the  two  forms 
of  money  may  circulate  at  par.  Changes  in  the  relative 
production  of  the  two  metals,  or  changes  in  the  demand 
for  them,  over  which  no  government  has  complete  control, 
may  cause  silver  to  rise  or  fall  relatively  to  gold.  Since 
the  value  of  coined  metal,  when  coinage  is  free,  cannot 
differ  perceptibly  from  the  value  of  uncoined  metal,  a  rise 
in  the  market  value  of  silver,  relatively  to  gold,  will  raise 
the  value  of  silver  dollars  above  that  of  gold  dollars.  In 
such  case  the  gold  displaces  the  silver  from  circulation. 
A  fall  in  the  market  value  of  silver  would  result  in  a  dis- 
placement of  gold  from  the  coinage. 

In  the  monetary  history  of  the  United  States,  silver  was 
at  one  time  overvalued,  in  terms  of  gold ;  at  another  time 
it  was  undervalued.  As  a  result  there  was  at  one  time  a 
tendency  for  gold  to  displace  silver  from  the  coinage ;  at 
another  time  silver  tended  to  displace  gold.  The  impossi- 
bility of  keeping  freely  coined  gold  and  silver  at  an  absolute 
parity  was  one  of  the  principal  causes  for  the  general 
adoption  by  the  chief  commercial  nations  of  the  mono- 
metallic system. 

9.    TJie  value  of  vioney  is  its  purchasing  power. 

Under  present  conditions  all  men  accept  money  in 
exchange  for  their  possessions  solely  with  reference  to  its 
employment  in  the  purchase  of  other  things.  We  may, 
therefore,  define  the  value  of  money  as  its  power  to  com- 
mand other  things  in  exchange,  or  briefly,  its  .purchasing 


MONEY  263 

power.  Other  commodities  are  valued  by  some  men  for 
what  they  will  bring  in  exchange,  by  other  men  for  the  satis- 
faction to  be  derived  from  them  directly  or  indirectly.  The 
ultimate  cause  of  the  value  which  men  who  hold  ordinary 
commodities  for  sale  ascribe  to  such  commodities  is  the  value 
ascribed  to  them  by  those  who  will  use  them  in  the  satis- 
faction of  wants.  There  are  practically  no  men  who  ascribe 
value  to  money  as  a  means  of  direct  satisfaction.  In  this 
respect,  accordingly,  the  value  of  money  is  a  unique  phe- 
nomenon, requiring  special  explanation. 

10.  The  value  of  money  is  measured   by    its  poiver   to 
command  commodities  in  general. 

The  value  of  money,  then,  is  its  purchasing  power. 
How  is  this  power  to  be  measured .''  Evidently  not  by 
reference  to  any  particular  commodity.  A  dollar  may  buy 
one  and  one  quarter  bushels  of  wheat  to-day  and  only  one 
and  one  fifth  bushels  to-morrow.  We  should  not  say  that 
the  value  of  money  has  declined,  but  that  the  price  of  wheat 
has  risen.  For  there  are  probably  many  other  commodities 
in  respect  to  which  the  purchasing  power  of  money  has 
increased.  To  form  a  true  estimate  of  the  value  of  money 
we  must  consider  its  power  to  command  commodities  in 
general.  In  order  to  measure  changes  in  the  value  of 
money  we  may  form  a  list  of  the  principal  commodities, 
showing  how  much  of  each  a  dollar  will  command  at  differ- 
ent dates.  By  the  method  of  averages  we  can  then  ascer- 
tain whether  the  general  purchasing  power  of  money  has 
changed.  This  method  has  long  been  employed  by  econo- 
mists, and  it  has  been  shown  that  through  long  periods  of 
time  the  value  of  money  fluctuates  widely.  A  dollar  will 
not  buy  so  much  to-day  as  it  would  have  bought  ten  years 
ago.  Very  likely  a  dollar  will  buy  more  ten  years  hence 
than  it  buys  to-day. 

11.  Changes  in  the  supply  of  money  tend  to  bring  about 
changes  in  the  value  of  money. 


264  INTRODUCTION   TO   ECONOMICS 

The  factors  which  determine  the  value  of  money,  and 
hence  the  general  level  of  prices,  are  so  numerous  and  com- 
plex that  only  a  provisional  account  of  them  can  be  given 
in  this  work.  It  is  quite  generally  agreed  that,  other  things 
equal,  the  greater  the  volume  of  money  there  is  in  the 
world,  the  lower  will  be  the  value  of  any  unit  of  it.  It  is, 
of  course,  true  that  there  are  in  operation  many  influences 
affecting  prices  besides  changes  in  the  volume  of  money. 
Hence  we  cannot  say  that  if  the  volume  of  money,  twenty 
years  hence,  shall  be  twice  as  great  as  it  is  to-day,  prices 
will  be  higher  than  they  are  to-day.  Yet  this  fact  does  not 
make  it  the  less  important  for  us  to  gain  a  clear  view  of 
the  effect  of  a  change  in  the  volume  of  money. 

Let  us  suppose  that  through  the  discovery  of  a  new  gold 
field  the  world's  supply  of  that  metal  is  perceptibly  in- 
creased: ^100,000,000  worth  of  gold,  let  us  say,  is  taken 
from  the  new  mines  every  year.  Some  of  the  new  gold 
may  be  used  in  the  arts,  but  the  greater  part  of  it  will  find 
its  way  to  the  mints  of  the  nations,  and  issue  thence  as 
coin. 

The  only  use  which  money  subserves  is  that  of  purchas- 
ing other  commodities.  The  fortunate  owners  of  the  new 
mines  will  therefore  enter  the  market  as  purchasers,  either 
of  consumable  commodities  or  of  capital  goods  or  rights 
to  capital  goods  —  stocks,  bonds,  etc.  There  is  no  reason 
why  the  production  of  goods,  whether  consumable  goods 
or  instruments  of  production,  should  at  once  increase  upon 
the  discovery  of  gold.  We  may  think  of  the  supply  of 
such  goods  as  substantially  unchanged.  Now,  new  pur- 
chasers, with  $100,000,000  to  spend,  appear  upon  the  mar- 
ket. It  is  quite  evident  that  competition  for  commodities 
will  increase,  and  hence  prices  will  rise. 

Let  us  assume,  for  the  moment,  that  the  rise  in  price  of 
the  commodities  purchased  by  the  first  owners  of  the  new 
gold  has  no  effect  in  stimulating  the  production  of  such 


MONEY  265 

commodities.  The  enterprisers  engaged  in  the  production 
of  these  commodities,  then,  will  enjoy  abnormally  large 
money  incomes  as  a  result  of  the  high  prices  at  which  they 
sell  their  products.  They  will  have  more  money  to  spend 
on  other  classes  of  commodities  for  their  own  use.  As  the 
production  of  these,  we  assume,  has  not  yet  been  affected, 
they  also  must  rise  in  price.  And  so  the  new  gold  will 
percolate  from  one  economic  stratum  to  another,  every- 
where raising  prices. 

Our  assumption  that  the  production  of  the  commodities 
demanded  by  the  original  owners  of  the  new  gold  remains 
unchanged  is  purely  arbitrary.  The  rise  in  prices  would  prob- 
ably lead  enterprisers  to  enlarge  their  mills,  or  to  run  them 
overtime,  and  this  would  require  morelaborersand  more  cap- 
ital. The  total  supply  of  labor  and  capital  at  the  command 
of  society  has  not,  however,  been  affected  by  the  increase 
in  the  volume  of  money.  The  only  way,  then,  in  which  an 
enterpriser  can  secure  additional  labor  and  capital  is  by 
enticing  these  agents  away  from  the  employment  of  other 
enterprisers.  And  this,  it  is  evident,  must  raise  the  rates 
of  wages  and  interest  in  the  district  where  the  expansion 
of  enterprise  occurs. 

After  the  rise  in  wages,  each  laborer  has  more  money 
to  spend ;  he  will  therefore  increase  his  purchases  of  the 
commodities  suitable  for  his  use.  The  supply  of  these, 
however,  has  not  yet  increased ;  their  price  is,  therefore, 
forced  to  a  higher  level.  Similarly,  the  increased  money 
income  of  the  capitalists  raises  the  prices  of  commodities 
taken  by  the  members  of  that  class.  Eventually  not  only 
the  price  of  all  finished  products,  but  the  price  of  all  raw 
materials  and  other  capital  goods,  and  of  all  labor,  will  be 
affected. 

The  new  gold  may  be  first  used  to  purchase  consumable 
goods,  or  it  may  be  used  to  purchase  stocks  or  bonds.  In 
\he  latter  case,  the  first  effect  is  an  increase  in  the  price  of 


266  INTRODUCTION   TO   ECONOMICS 

these  securities.  But  tlie  sellers  of  the  securities  will  use 
the  money  to  buy  other  things.  Eventually  the  effect  must 
be  felt  in  the  market  for  commodities  and  labor. 

12.  TJie  issue  of  paper  money  by  a  govermnent  affects 
prices  in  the  same  way  that  an  increase  in  standard  money 
affects  them. 

Instead  of  assuming  that  the  supply  of  money  is  in- 
creased through  new  gold  discoveries,  we  may  assume  that 
such  increase  in  the  money  supply  is  brought  about  through 
an  issue  of  paper  money  by  the  government.  Suppose  that 
the  United  States  Government,  in  order  to  finance  projected 
irrigation  works,  issues  $100,000,000  in  paper  money.  This 
money  will  find  its  way  into  circulation  through  the  pur- 
chase, by  the  Government,  of  additional  supplies  and  the 
payment  of  wages  to  new  employees.  The  supply  of  steel, 
cement,  and  other  commodities  needed  by  the  Government, 
however,  is  not  increased  at  once  by  the  issue  of  new  money ; 
hence  the  price  of  these  supplies  must  rise  when  the  Gov- 
ernment enters  the  market  as  an  unanticipated  purchaser. 
Similarly,  wages  are  forced  up  by  the  new  demand  for 
labor  created  in  this  way.  Through  attempted  expansion 
of  business  and  through  increased  liberality  of  expenditure, 
the  enterprisers  and  laborers  first  affected  by  the  increase 
in  the  money  supply  transmit  its  effects,  in  the  form  of  in- 
creased prices,  to  men  engaged  in  other  industries.  In  the 
end  general  prices  and  general  costs  are  on  a  higher  level 
than  they  would  otherwise  have  been. 

13.  The  employment  of  substitutes  for  m.oney  in  effecting 
excJianges  operates  as  an  increase  in  the  stipply  of  jnoney. 

Not  all  exchanges  are  effected  through  the  medium  of 
money.  Barter  exists  even  to-day,  although  this  form  of  ex- 
change may  be  ignored,  as  of  very  slight  importance. 
Many  exchanges  —  indeed,  much  the  greater  number,  in  a 
society  like  our  own  —  are  effected  through  the  medium  of 
various  substitutes  for  money.     Let  us  suppose  that   A,  a 


MONEY  267 

person  of  unquestioned  financial  standing,  buys  of  B  com- 
modities worth  $100,  and  instead  of  paying  cash,  gives  a 
promissory  note,  due  in  six  months.  B  in  turn  may  buy 
5iOO  worth  of  goods  from  C,  paying  for  them  not  with 
cash,  but  with  A's  note,  properly  indorsed.  C  may  use 
the  same  note  to  effect  a  purchase.  At  any  given  time  a 
vast  number  of  such  notes  may  be  at  work  effecting  ex- 
changes, although  each  one  may  be  transferred  only  two 
or  three  times  before  its  maturity.  The  effect  of  the  use 
of  such  notes  as  a  means  of  exchange  is  the  same  as  that 
of  an  increase  in  the  supply  of  money.  A  man  who  can 
use  a  note  in  this  way  is  enabled  to  enter  the  market  for 
the  purchase  of  goods  as  he  could  not  have  done  if  sellers 
all  insisted  upon  cash  payment.  The  effective  demand  for 
commodities,  therefore,  is  increased,  just  as  it  would  be  by 
an  increase  in  money.  We  need  not  at  this  point  carry 
further  the  analysis  of  the  effects  of  the  introduction  of 
such  substitutes  for  money,  as  these  effects  will  receive  full 
discussion  in  the  next  chapter. 

14.  Changes  in  the  volnuic  of  business  ajfect  the  value  of 
money. 

The  value  of  money,  as  we  have  seen,  is  affected  by 
changes  in  the  volume  of  money  and  in  the  use  of  substitutes 
for  money.  It  is  also  affected  by  changes  in  the  volume  of 
business  to  be  transacted  through  the  use  of  money.  Where 
most  men  produce  for  themselves  the  principal  commodities 
which  they  need,  exchanging  only  their  surplus  for 
luxuries,  a  very  little  money  will  meet  the  requirements  of 
trade.  Where,  on  the  other  hand,  men  produce  almost  ex- 
clusively for  sale,  a  large  volume  of  money  or  of  substitutes 
for  money  is  required.  If  we  imagine  that  men  suddenly 
change  from  the  system  of  production  for  immediate  con- 
sumption to  the  system  of  production  for  the  market,  with- 
out any  change  in  the  volume  of  money  and  of  its  substitutes, 
we  can  easily  see  that  the   price  level  must  be  lowered. 


268  INTRODUCTION  TO   ECONOMICS 

Where  one  commodity  under  the  earlier  system  was  offered 
for  sale  to  the  possessors  of  money,  one  hundred  may  be 
offered  under  the  later  system.  Some  sellers  of  commodities 
would  then  find  that  at  the  scale  of  values  originally  exist- 
ing they  would  be  unable  to  find  purchasers  with  money  to 
pay.  They  would  accordingly  reduce  prices,  and  so  attract 
to  themselves  a  part  of  the  money  supply.  This  would  leave 
other  sellers  without  buyers,  and  these  in  turn  would  lower 
prices.  Thus  the  price  level  would  fall  or,  what  amounts 
to  the  same  thing,  the  value  of  money  would  rise,  until  all 
sellers  could  find  buyers  at  the  prevailing  prices. 

The  assumption  that  the  system  of  production  could 
change  thus  rapidly  without  a  change  in  the  volume  of  the 
media  of  exchange  involves  unrealities,  as  we  know  that 
exchange  and  the  medium  of  exchange  must  evolve  to- 
gether. Yet  it  points  to  a  real  fact :  that  exchange  may 
expand  more  rapidly  than  the  volume  of  the  media  of  ex- 
change, necessitating  a  lower  price  level. 

15.  An  increase  in  the  supply  of  money  tends  to  raise 
prices  ;  but  there  is  no  definite  relation  betzveen  the  degree 
in  ivJiich  the  money  supply  is  increased  and  the  degree  in 
whicJi  prices  rise. 

It  must  now  be  evident  that  changes  in  the  volume  of 
money  are  not  alone  sufficient  to  explain  changes  in  the 
value  of  money,  or  price  changes.  The  development  of 
substitutes  for  money  and  changes  in  the  volume  and 
character  of  business  transactions  must  also  be  taken  into 
account.  Therefore,  although  we  may  say  that  an  increase 
in  the  volume  of  money  will,  other  things  equal,  raise  general 
prices,  we  cannot  say  in  what  degree  any  specific  addition 
to  the  money  supply  will  raise  prices.  A  doubHng  of  the 
money  supply  of  the  world  might  conceivably  double  prices. 
In  all  probability,  however,  prices  would  be  increased  by 
less  or  by  more  than  one  hundred  per  cent.  For  the  read- 
justments consequent  upon  such  an  extraordinary  expansion 


MONEY  269 

in  the  volume  of  money  would  probably  result  in  vital 
changes  in  the  volume  and  character  of  business,  the  nature 
of  which  it  would  be  impossible  to  predict.  The  reader  is 
cautioned  against  the  view  that  an  increase  in  the  money 
supply,  brought  about  in  any  way  that  is  known  to  practical 
experience,  can  leave  the  industrial  mechanism  unchanged 
while  changing  the  scale  of  prices. 

We  may  also  say  that,  other  things  equal,  all  prices  will 
be  raised  by  any  important  increase  in  the  volume  of  money. 
But  we  cannot  say  that  all  prices  will  rise  in  the  same  pro- 
portion. Indeed,  this  is  something  that  a  little  reflection  on 
business  conditions  shows  to  be  impossible.  The  supply  of 
some  commodities  is  easily  increased,  while  the  supply  of 
other  commodities  can  be  increased  only  after  the  lapse  of  a 
considerable  time.  If  the  new  money  is  spent  largely  on 
commodities  of  the  first  class,  the  attendant  rise  in  price  is 
quickly  counteracted,  in  some  degree,  by  increase  of  produc- 
tion. If  it  is  spent  on  commodities  of  the  second  class,  there 
can  for  a  time  be  no  such  counteracting  influence. 

16.  CJiangcs  in  the  vo/mnc  of  money  give  rise  to  practical 
economic  questions  of  the  greatest  importance. 

The  fact  that  not  all  prices  rise  in  the  same  degree,  and 
the  fact  that  some  classes  of  business  relations  cannot  be 
immediately  adjusted  to  price  changes,  renders  the  question 
of  increase  or  decrease  in  the  volume  of  money  of  vital 
practical  importance.  Some  social  classes  are  affected 
favorably  and  other  classes  are  affected  adversely  by  such 
changes. 

When  general  prices  are  rising,  the  wages  of  labor  also 
tend  to  rise.  But  it  may  take  some  time  after  prices  have 
begun  to  rise  before  enterprisers  decide  to  extend  their 
business  operations.  The  demand  for  labor,  accordingly, 
does  not  for  a  time  increase  and  wages  remain  unchanged. 
The  laborer  receives  no  higher  wages  per  week  or  month  ; 
the  commodities  he  buys  with    his  wages  have    risen    in 


270  INTRODUCTION   TO    ECONOMICS 

price.  It  follows  that  the  command  of  the  laborer  over 
the  necessaries  and  comforts  of  life  is  for  the  time  dimin- 
ished. Eventually,  to  be  sure,  enterprisers  will  endeavor 
to  enlarge  their  businesses,  and  wages  will  rise.  But  if 
the  prices  of  commodities  continue  to  rise,  it  may  well  be 
that  for  a  long  period  of  time  the  rise  in  money  wages  will 
not  be  an  adequate  offset  for  the  increased  expense  of  liv 
ing.  It  is  a  well-known  fact  that  during  the  Civil  War 
the  prices  of  commodities  rose  far  more  than  the  price  of 
labor. 

For  many  services  compensation  is  fixed  by  law  or  by 
custom.  The  salaries  of  public  officials  remain  fixed  through 
long  periods  of  time,  notwithstanding  changes  in  the  price 
level.  The  postal  employee  receiving  ;^2000  a  year  is  seri- 
ously injured  if  prices  of  commodities  rise,  since  years 
may  elapse  before  the  Government  grants  him  an  increase 
of  salary.  Physicians'  fees,  in  most  cases,  are  regulated  by 
custom  and  can  seldom  be  increased  on  account  of  an  ad- 
vance in  general  prices. 

The  business  relations  most  seriously  disturbed  by  price 
changes,  however,  are  those  of  creditor  and  debtor.  Let 
us  suppose  that  a  farmer  has  borrowed  ^10,000,  agreeing 
to  pay  off  the  loan  in  ten  years,  together  with  annual  inter- 
est at  six  per  cent.  After  the  contract  has  been  made, 
general  prices,  we  will  assume,  rise  twenty  per  cent.  The 
farmer  does  not  have  to  pay  more  than  $600  interest  each 
year,  although  the  purchasing  power  of  that  sum  has  de- 
clined twenty  per  cent.  At  the  end  of  the  ten  years,  he 
will  not  need  to  pay  more  than  $10,000,  although  this  sum, 
for  the  same  reason,  represents  a  lower  value.  The  creditor 
has  been  injured  through  the  change  in  the  price  level  just 
as  much  as  he  would  have  been  if  the  debt  had  been  arbi- 
trarily scaled  down  to  $8333,  prices  remaining  unchanged. 
The  farmer,  on  the  other  hand,  has  gained  materially.  He 
receives  higher  prices   for  what  he    has  to  sell,  and  so  is 


MONEY  271 

enabled  to  pay  the  annual  interest  and  the  principal  when 
due  with  much  less  sacrifice  than  would  otherwise  have 
been  necessary. 

Enterprisers  as  a  class  are  benefited  through  a  rise  in 
general  prices.  What  they  have  to  sell  commands  a  higher 
price ;  their  costs  of  production  increase,  but  not  propor- 
tionately. Mention  has  already  been  made  of  the  fact  that 
wages  may  not  rise  so  rapidly  as  prices.  Furthermore, 
most  enterprisers  have  some  charges  to  meet  that  remain 
unchanged  from  year  to  year.  If  they  occupy  buildings 
and  land  not  owned  by  themselves,  these  are  probably 
held  under  long  time  leases.  Until  it  is  necessary  to  re- 
new such  leases,  the  rental  cannot  be  adjusted  to  the  change 
in  the  price  level.  Most  enterprisers  are  heavily  in  debt, 
and  the  rise  in  the  level  of  prices  has  the  effect  of  reduc- 
ing the  burden  of  such  debts,  as  in  the  case  of  the  farmer 
of  our  illustration.  A  period  of  rising  prices,  to  the  active 
business  man,  is,  therefore,  a  period  of  prosperity,  whether 
it  is  a  period  of  prosperity  to  the  people  as  a  whole  or  not. 

We  have  only  to  reverse  our  argument  to  show  that  in  a 
period  of  falling  prices,  or  rising  value  of  money,  the  wage 
earners  as  a  class  gain,  because  wages  do  not  fall  so  rapidly 
as  prices ;  those  receiving  salaries  fixed  by  law  or  custom 
gain  yet  more,  because  a  readjustment  of  such  incomes  to 
the  new  scale  of  prices  is  long  delayed ;  creditors  gain 
through  increase  in  the  purchasing  power  of  the  interest 
and  principal  due  them.  The  enterprisers  as  a  class  find 
profits  succeeded  by  losses,  and  complain  bitterly  of  busi- 
ness depression. 

17.  A  monetary  standard  of  fluctuating  value  results  in 
serious  hards/rips  ;  it  is  therefore  natural  that  efforts  should 
be  made  to  render  the  standard  more  stable  through  govern- 
'>nental  action. 

The  value  of  money  can  neither  rise  nor  fall  without  in- 
flicting unmerited  hardship  upon  some  members  of  society. 


272  INTRODUCTION   TO   ECONOMICS 

Any  change  in  the  value  of  money,  therefore,  is  an  evil, 
The  evils  of  a  rise  in  the  value  of  money  are,  however,  more 
easily  perceived  than  the  evils  resulting  from  a  fall  in  the 
value  of  money.  When  money  rises  in  value — or,  what 
amounts  to  the  same  thing,  prices  fall  —  enterprisers  incur 
losses,  and  restrict  their  operations,  reducing  their  working 
force  as  far  as  possible.  Many  debtors  find  themselves  un- 
able to  sustain  their  burdens,  and  become  bankrupt.  The 
hardships  of  unemployment  and  bankruptcy  quickly  attract 
public  attention.  The  hardships  arising  from  a  fall  in  the 
value  of  money,  or  rising  prices,  are  more  widely  diffused 
and  less  patent  to  the  eye  of  the  observer.  Wage  earners 
and  the  recipients  of  fixed  incomes,  whether  from  labor  or 
from  loaned  capital,  encounter  greater  and  greater  difficulty 
in  making  ends  meet,  but  this  fact  receives  little  attention  at 
a  time  when  enterprisers  great  and  small  are  enjoying  pros- 
perity. Accordingly,  it  is  quite  natural  that  when  prices  are 
falling  men  should  endeavor  to  mend  matters  through  the 
action  of  government,  while  the  evil  effects  of  a  general  rise 
in  prices  are  usually  left  to  mend  themselves. 

18.  /;/  order  to  check  the  fall  of  prices  wJiicJi  occurred  in 
the  period  frvni  1874  to  1897,  it  was  tirged  by  many  tJiat 
silver  should  be  restored  to  free  coinage,  so  as  to  increase  the 
money  supply  of  the  world. 

In  the  period  from  1874  to  1897  the  prices  of  com- 
modities steadily  declined.  In  1897  a  dollar  would  pur- 
chase approximately  the  same  amount  of  commodities  that 
^1.50  would  have  purchased  in  1874.  Many  classes  of 
producers  were  seriously  injured  by  this  decline  in  prices; 
business  depression  appeared  at  times  to  threaten  wide- 
spread ruin.  The  debtor  classes  in  all  modern  countries 
were  seriously  burdened,  and  in  some  parts  of  the  United 
States,  especially  in  the  newer  agricultural  states  of  the 
West,  a  popular  demand  arose  for  an  increase  in  the 
supply  of  money  through  the  restoration  of  silver  to  free 


MONEY  273 

coinage  at  the  ratio  of  16  to  i  — the  ratio  prevailing  in  the 
United  States  prior  to  1873. 

It  is  not  possible,  in  this  book,  to  enter  into  the  argu- 
ments that  were  urged  for  and  against  the  free  coinage  of 
silver.  We  may  consider,  however,  the  probable  effects 
of  such  a  policy  upon  the  American  monetary  system. 

19.  Tlic  adoption  of  free  silver  in  1896  would  probably 
have  expelled  gold  from  circulation  in  the  United  States.  It 
would  have  reduced  the  value  of  gold  and  ivould  have 
raised  the  value  of  silver. 

In  1896  the  market  value  of  silver  had  fallen  so  low  that 
an  ounce  of  silver  was  worth  less  than  one  thirtieth  of 
the  value  of  an  ounce  of  gold.  Consequently,  if  silver 
had  been  admitted  to  free  coinage,  it  would  have  been 
very  profitable  to  buy  up  uncoined  silver,  both  in  America 
and  in  other  countries,  present  it  at  the  mints,  and  exchange 
the  coined  silver  for  gold,  so  long  as  any  gold  coins  remained 
in  circulation.  It  would  obviously  have  been  only  a  very 
short  time  before  gold  would  have  disappeared  entirely 
from  circulation. 

The  great  demand  upon  the  silver  supply  that  would  thus 
have  been  occasioned  would  no  doubt  have  increased  the 
value  of  that  metal.  The  gold  displaced  from  the  Ameri- 
can coinage  would  have  been  thrown  upon  the  markets 
of  other  countries,  and  would  have  reduced  the  value  of 
gold  there.  Nevertheless,  an  ounce  of  gold  would  proba- 
bly have  continued  to  command  more  than  sixteen  ounces 
of  silver  —  perhaps  twenty  ounces.  A  silver  dollar  would 
then  have  been  worth  less  than  a  dollar  in  gold,  even 
though  gold  had  fallen.  Measured  in  commodities,  the 
depreciation  of  the  dollar  would  be  still  greater.  That  is, 
general  prices  in  the  United  States  would  have  been 
forced  to  a  higher  level. 

20.  A  n  international  agreement  for  the  universal  adoption 
of  bimetallism  miglit  Jiave  prevented  freely  coined  silver  from 
expelling  gold  from  the  cunency. 


274 


INTRODUCTION   TO    ECONOMICS 


Many  persons  who  shrank  from  a  poHcy  which  would 
probably  have  substituted  a  silver  standard  for  the  gold 
standard  in  the  United  States,  nevertheless  favored  the 
adoption  of  free  coinage  of  silver  if  the  other  commercial 
nations  could  be  induced  to  follow  the  same  plan. 

If  all  the  countries  of  the  world  had  agreed  to  coin  sil- 
ver and  gold  freely  at  the  same  ratio,  it  is  quite  probable  that 
coins  of  both  metals  would  have  continued  to  circulate  side 
by  side.  The  chief  reason  why  gold  would  leave  the  cir- 
culation of  a  single  country,  if  placed  at  an  unfavorable 
ratio  with  freely  coined  silver,  is  that  in  other  countries  it 
is  given  a  higher  coinage  value.  More  gold  would  be  used 
in  the  arts,  perhaps,  but  much  of  it  would  remain  in  the 
coinage  if  all  countries  gave  it  the  same  coinage  value, 
relatively  to  silver. 

21.  Rise  in  prices  in  tJie  decade  1897- 1906  checked  agita- 
tion for  the  free  coinage  of  silver. 

The  adoption  by  the  chief  nations  of  free  coinage  of 
silver  would  no  doubt  have  resulted  in  a  higher  level  of 
prices.  Other  forces  affecting  prices  had,  however,  begun 
to  operate  while  the  free-silver  movement  was  still  gaining 
strength.  The  production  of  gold  was  steadily  increas- 
ing;  in  the  decade  1890  to  1900  the  amount  of  gold  pro- 
duced exceeded  that  of  any  earlier  decade  in  the  history  of 
the  world.  The  annual  production  in  the  years  1901-1908 
was  still  greater,  and  the  increase  in  the  supply  reduced 
the  value  of  gold,  or,  what  amounts  to  the  same  thing,  raised 
the  prices  of  commodities.  When  it  became  evident  that 
the  rise  in  prices  was  likely  to  continue,  agitation  for  the 
adoption  of  the  policy  of  free  coinage  of  silver  practically 
ceased. 

22.  A  govermncjit  may  raise  orloivcr  the  vahie  of  money 
by  2ncreasing  or  reducing  the  amount  of  paper  money  in  cir- 
cnhntion. 

The  evils  of  falling  prices  are  so  readily  perceived  by 


MONEY  275 

almost  every  one,  that  in  times  of  falling  prices  plans  are 
usually  put  forward  for  releasing  the  price  level  from  the 
uncertainties  attendant  upon  the  production  of  gold  and 
silver  by  supplementing  metallic  money  with  paper  money 
issued  by  government.  Advocates  of  such  plans  usually 
propose  that  whenever  general  prices  are  found  to  be 
falling,  the  government  shall  issue  additional  paper  money. 
When  prices  are  rising,  paper  money  received  at  the  public 
treasury,  it  is  proposed,  shall  be  destroyed,  until  a  reduc- 
tion in  the  money  supply  checks  the  rise  in  prices. 

In  practice,  paper  money,  when  issued,  usually  takes 
the  form  of  notes,  issued  in  behalf  of  the  government  and 
alleged  to  be  payable  at  the  treasury  on  demand.  But  a 
government  of  a  sovereign  state  cannot  be  compelled  to 
meet  its  promises  unless  it  chooses  to  do  so.  Hence  the 
person  who  receives  such  a  note  must  take  it  with  the  in- 
tention of  parting  with  it  in  the  purchase  of  goods  or  in 
the  payment  of  debts,  not  of  presenting  it  at  the  treasury 
for  specie.  These  notes  therefore  represent  a  net  addition 
to  the  money  supply. 

In  order  to  give  such  notes  currency,  the  government 
endows  them  with  the  legal  tender  quality.  If  the  volume 
of  paper  money  is  narrowly  limited,  it  may  circulate  at 
par.  If  occasionally  we  receive  paper  money  in  exchange, 
we  know  that  we  can  use  it  for  the  payment  of  taxes  or 
debts.  So  certain  of  this  may  we  be,  under  the  conditions, 
and  so  confident  that  others  are  in  a  like  position,  that  we 
do  not  hesitate  to  accept  paper  money  at  par  in  exchange 
for  our  goods  and  services. 

If,  however,  an  enormous  amount  of  paper  money  is 
issued  by  the  government,  so  that  we  are  all  likely  to  re- 
ceive more  of  it  in  exchange  than  we  can  certainly  use  at 
par,  we  begin  to  look  upon  it  with  suspicion.  We  exchange 
it,  if  we  can,  for  "hard  money"  —  gold  or  silver;  if  pos- 
sible, we  stipulate  that  we  shall  be  paid  in  hard  money  for 


276  INTRODUCTION   TO   ECONOMICS 

our  commodities  or  services,  offering  our  goods,  if  neces- 
sary, at  lower  prices  than  we  would  accept  if  paid  in  paper. 
Relatively  to  gold,  paper  depreciates.  If  there  is  very 
much  of  it  issued,  no  one  pays  gold  if  he  can  avoid  it,  but 
uses  paper  instead.  Thus  specie  disappears  from  circula- 
tion, and  paper  becomes  the  only  money  in  use.  Under 
the  circumstances  it  is  the  worst  possible  kind  of  money  : 
it  fluctuates  widely  in  value,  falling  with  rumors  of  addi- 
tional issues,  rising  when  it  is  rumored  that  the  govern- 
ment intends  to  redeem  it.  At  every  change  in  its  value 
some  men  gain  unmerited  profits  and  others  suffer  un- 
merited losses. 

If,  as  has  been  said,  a  government  exercises  great  mod- 
eration in  the  issue  of  paper  money,  depreciation  may  not 
occur.  The  increase  in  money  will  tend  to  raise  prices,  but 
not  in  very  great  degree,  and  if  prices  are  tending  down- 
ward this  effect  may  be  beneficial.  Why,  then,  do  practi- 
cally all  students  of  monetary  science  agree  that  paper 
money  is  always  an  unmitigated  evil .-'  Because  govern- 
ments almost  never  exercise  moderation  in  the  issue  of 
paper  money.  They  resort  to  paper  money  in  time  of 
need,  usually  while  carrying  on  war.  Thus  they  obtain 
funds  without  burdening  the  people  with  taxation.  As 
the  expenses  of  the  war  increase,  more  and  more  paper 
money  is  issued,  until  hard  money  is  driven  out  of  circula- 
tion, and  the  redundant  paper  currency  falls  lower  and 
lower  in  value,  as  evidenced  by  constantly  rising  prices. 

Another  objection  to  attempts  on  the  part  of  govern- 
ment to  regulate  prices  through  the  use  of  paper  money 
is  that  while  it  is  practicable,  politically,  to  increase  the 
circulation  when  prices  are  falling,  it  is  not  practicable  to 
reduce  the  circulation  when  prices  are  rising.  In  order  to 
retire  paper  money  from  the  circulation,  it  is  necessary 
to  resort  to  additional  taxation  which  will,  directly  or  in- 
directly, bring  the  money  to  be  retired  into  the  treasury.    To 


MONEY  277 

increase  taxation  for  this  purpose  would  be  a  very  unpopu- 
lar policy,  especially  since  a  majority  of  the  population  is 
likely  to  look  upon  rising  prices  as  a  sii^n  of  prosperity, 
and  therefore  an  unmixed  good.  The  plan  of  keeping 
prices  at  a  fixed  level  by  the  use  of  paper  money  must 
therefore  be  dismissed  as  impracticable. 

23.  A  ciinriicy  based  iipoii  gold  or  silver  freely  coined 
displays  a  tendency  toward  reasoiable  stability  of  value  un- 
der modern  conditions. 

So  long  as  the  production  of  the  precious  metals  was 
dependent  upon  the  activity  of  men  of  small  capital,  work- 
ing on  their  own  account,  only  the  richest  fields  could  be 
worked,  and  these  only  for  a  limited  period  of  time.  The 
supply  of  precious  metals  depended,  therefore,  upon  the 
chance  discovery  of  new  fields,  and  was  consequently  very 
irregular.  At  present  the  principal  supply  of  the  precious 
metals  comes  from  the  reduction,  by  large  scale  enter- 
prise, of  low  grade  ores,  which  are  found  in  large  masses 
in  many  parts  of  the  world.  If  the  supply  of  gold  in- 
creases so  rapidly  that  the  value  of  gold  money  falls, 
or,  what  amounts  to  the  same  thing,  general  prices  rise, 
the  production  of  gold  is  discouraged  through  the  rise  in 
price  of  labor  and  the  materials  and  appliances  used  in 
gold  production.  If  the  supply  of  gold  does  not  keep 
pace  with  the  demand  for  it,  and  general  prices  fall,  the 
production  of  gold  is  encouraged  by  the  decline  in  wages 
and  in  the  prices  of  goods  used  in  the  production  of  gold. 
We  see,  then,  that  there  are  forces  at  work  which  restrict 
fluctuations  in  the  value  of  money.  We  must  not,  how- 
ever, exaggerate  the  potency  of  these  forces.  Within 
limits  which  are  not  so  narrow  as  would  be  socially  desir- 
able, the  value  of  freely  coined  money  fluctuates  from  year 
to  year  and  from  decade  to  decade. 

24.  Summary. 

Whatever    men    regularly  accept  in  payment  for  their 


278  INTRODUCTION   TO   ECONOMICS 

services  or  in  exchange  for  their  goods,  with  the  sole  pur- 
pose  of  exchanging  it  for  other  services  or  goods,  is 
money.  The  primary  function  of  money  is  that  of  a  me- 
dium of  exchange ;  money  serves  also  as  a  means  of  stor- 
ing value,  as  a  standard  of  value,  and  as  a  standard  of  de- 
ferred payments. 

In  order  that  money  may  be  uniform  in  value,  its  issue 
must  be  regulated  by  government.  As  a  rule,  a  standard 
form  of  money  is  established,  and  the  government  merely 
certifies  the  weight  and  fineness  of  metal  contained  in  this 
form  of  money.  Other  forms  of  money  are  issued  in 
limited  quantities,  and  it  is  the  aim  of  a  well-regulated 
government  to  maintain  these  forms  at  a  parity  with  the 
standard  form.  If  there  is  more  than  one  standard  form, 
maintenance  of  parity  between  them  is  difficult,  if  not  im- 
possible. When  a  government  fails  to  maintain  its  various 
forms  of  money  at  a  parity,  the  less  valuable  forms  tend 
to  displace  the  more  valuable  forms  from  the  circulation. 

The  value  of  money  is  measured  by  its  purchasing 
power.  The  purchasing  power  of  money  is  continually 
fluctuating,  owing  to  changes  in  the  supply  of  and  the 
demand  for  money.  Changes  in  the  supply  of  money 
may  be  due  to  changes  in  the  output  of  the  metal  from 
which  standard  money  is  made,  or  to  changes  in  the 
volume  of  non-standard  forms  issued  by  government. 
Changes  in  the  demand  for  money  may  be  due  to  changes 
in  the  general  character  of  business,  or  to  increase  or  de- 
crease in  the  volume  of  substitutes  for  money. 

A  rise  in  the  value  of  money  is  tantamount  to  a  fall 
in  prices ;  a  fall  in  the  value  of  money,  to  a  rise  in  prices. 
General  changes  in  the  price  level  inflict  serious  injury 
upon  some  classes  and  give  unmerited  gains  to  other 
classes.  Hence  a  popular  demand  for  governmental 
regulation  of  the  price  level  through  expansion  or  contrac- 
tion of  the  money  supply.     The  free  silver  movement  of 


mone:y  279 

recent  years  is  explainable  upon  this  principle.  The  adop- 
tion of  free  silver  by  the  United  States  would  probably 
have  raised  the  world  level  of  gold  prices  ;  it  would  have 
placed  prices  in  the  United  States  upon  a  silver  basis. 

Under  ideal  conditions,  general  changes  in  the  price  level 
might  be  prevented  through  the  issue  or  retirement  of  pa- 
per money.  Under  existing  conditions,  since  the  pressure 
for  higher  prices  is  always  stronger  than  the  pressure  for 
lower  ones,  a  consistent  policy  of  issue  of  paper  money  is 
impracticable.  The  only  practicable  corrective  of  rising 
prices  is  the  automatic  reduction  in  the  output  of  gold  re- 
sulting from  the  increased  cost  of  extracting  gold  from  the 
ore,  just  as  the  only  practicable  corrective  of  falling  prices 
is  the  automatic  increase  in  the  gold  supply  resulting  from 
lower  cost  of  gold  extraction. 


CHAPTER    XVI 

FINANCIAL   INSTITUTIONS:  THE   BANK 

1.  An  important  function  of  the  viodcni  economic  organi- 
zation is  the  placing  of  the  control  of  capital  in  the  hands 
of  those  wJio  can  use  it  to  the  greatest  advantage. 

In  a  complex  industrial  society  it  is  natural  that  there 
should  be  some  men  possessing  capital  who  are  unable  or 
unwilling  to  employ  it  in  business  undertakings  under  their 
own  management.  Some  men,  while  able  to  use  part  of 
their  capital  in  the  conduct  of  businesses  under  their  own 
control,  are  unable  to  use  all  of  it  advantageously.  And 
some  men,  while  able  to  use  all  their  capital  part  of  the 
time,  fail  to  find  use  for  it  during  some  weeks  or  months 
of  the  year.  On  the  other  hand,  there  are  those  who  have 
not  enough  capital  of  their  own  for  the  proper  exploitation 
of  the  opportunities  for  its  employment  which  they  com- 
mand, and  still  others,  while  having  capital  enough  during 
the  greater  part  of  the  year,  require  an  additional  amount 
during  certain  seasons. 

Accordingly,  one  of  the  functions  of  the  modern  indus- 
trial organization  is  the  transfer  of  the  control  of  capital 
from  those  who  have  a  superfluity  of  it  to  those  who  can 
use  it  profitably.  This  function,  which  in  view  of  the  enor- 
mous amount  of  capital  to  be  thus  transferred  is  one  of 
vast  importance,  may  be  designated  by  the  term  "finance." 
Institutions  designed  primarily  to  effect  the  transfer,  or 
"placing,"  of  capital  are  known  as  financial  institutions. 
It  is  to  be  noted  that  we  are  here  using  the  word  "finance  " 
in  a  sense  in  some  respects  more  restricted,  in  some 
respects  broader,  than  is  usually  conveyed  by  the  term. 
But  we  are  justified  in  this  by  the  analogies  of  such  words 

2S0 


FINANCIAL   INSTITUTIONS:    THE   BANK  281 

as  "  capital,"  "  rent,"  "labor,"  etc.,  which  have  one  mean^ 
ing  in  economics  and  a  slightly  different  meaning  in  popu- 
lar language. 

2.    The  transfer  of  the  control  of  capital  may   take    the 
form  of  a  loan  or  of  a  partnership  agreement. 

Let  us  suppose  that  a  mine  operator  holds  a  lease  of  ad- 
vantageously situated  coal  lands.  To  develop  these  lands 
he  needs,  we  will  say,  a  capital  of  $100,000.  A  retired 
merchant  in  the  vicinity  has  $100,000  from  which  he  de- 
sires to  get  an  income  without  the  labor  of  managing  a  busi- 
ness on  his  own  account.  The  mine  operator  may  borrow 
the  $100,000,  agreeing  to  pay  a  stipulated  rate  of  interest. 
On  the  other  hand,  he  may  be  willing  to  form  a  partnership 
with  the  owner  of  the  capital,  agreeing  to  share  the  profits 
in  fixed  proportions.  In  either  case  the  capital  is  virtually 
placed  under  the  control  of  the  mine  operator.  From  a 
legal  point  of  view  the  distinction  between  the  two  methods 
of  transfer  of  capital  is  clear.  If  the  transfer  is  effected 
through  a  loan,  the  mine  operator  becomes  the  legal  owner 
of  the  goods  in  which  the  capital  is  invested,  subject  to  the 
claims  of  the  lender  for  interest  and  principal.  The  lender  * 
has  no  voice  in  the  management  of  the  business.  If  the 
transfer  of  capital  is  effected  through  a  partnership  agree- 
ment, the  capitalist  becomes  part  owner  of  all  the  capital 
goods  employed  in  the  business,  and  is  entitled  to  a  voice 
in  the  management  of  it.  From  an  economic  point  of 
view,  the  chief  distinction  is  that  in  the  case  of  a  loan 
transfer  of  capital,  the  capitalist  receives  a  fixed  income, 
not  affected  by  the  vicissitudes  of  the  business,  while  in  the 
case  of  the  partnership  transfer,  the  capitalist  receives  a 
share  of  the  proceeds  of  the  business,  fluctuating  with  the 
alternation  of  prosperity  and  depression. 

3.  A  productive  loan  is  the  transfer  of  capital,  reduced  to 
terms  of  money  value,  usually  under  a  definite  agreement  as 
to  charges  for  its  use  and  as  to  time  of  repayment. 


282  INTRODUCTION   TO   ECONOMICS 

In  its  simplest  form  a  loan  is  a  transfer  of  a  sum  oi 
money  from  one  person  to  another,  with  the  stipulation  that 
a  certain  return  shall  be  paid  for  its  use  and  that  at  some 
future  time,  usually  specified,  an  equivalent  sum  of  money 
shall  be  repaid.  The  borrower  naturally  transforms  the 
money  thus  obtained  into  goods  at  the  earliest  possible 
moment.  If  the  goods  purchased  are  designed  for  sale  or 
for  use  in  further  production,  the  loan  is  virtually  the 
transfer  of  capital.  Such  a  loan  is  called  a  productive  loan. 
If  the  money  is  spent  for  commodities  for  consumption,  the 
loan  is  called  a  consumer's  loan.  The  productive  loan  is 
by  far  the  more  common,  and  we  shall  concern  ourselves 
chiefly  with  it. 

4.    A  loan  may  be  disguised  under  the  form  of  a  sale. 

Very  frequently  loans  are  disguised  under  the  form  of 
sales  "on  credit."  The  seller,  instead  of  demanding  spot 
cash  for  his  wares,  may  agree  to  wait  for  a  certain  period 
of  time  —  say,  th^ee  months  —  before  demanding  payment. 
In  this  case  the  seller  really  lends  the  buyer  a  sum  equal  to 
the  price  of  the  goods.  A  company  engaged  in  the  manu- 
facture of  agricultural  implements  sells  a  self-binder  to  a 
farmer.  The  latter  has  not  the  ready  cash  to  pay  for  it, 
but  expects  to  have  the  necessary  sum  four  months  later, 
when  he  sells  his  crops.  He  may  borrow  the  money  from 
a  neighbor,  giving  his  note,  payable  in  four  months,  with 
interest.  Or,  instead  of  borrowing  the  money  and  paying 
cash  for  the  machine,  the  farmer  may  buy  it  "  on  time," 
agreeing  to  pay  for  it  at  the  end  of  four  months.  In  this 
case  we  sometimes  say  that  the  farmer  has  purchased  the 
machine  with  his  credit.  If  we  analyze  the  transaction  into 
its  elements,  we  shall  see  that  this  expression  is  inaccurate. 
The  company  has  not  merely  sold  the  machine;  it  has  also, 
in  effect,  loaned  the  farmer  the  money  with  which  to  pay  for 
it.  Every  sale  "on  time"  or  "on credit"  is  a  double  transac- 
tion, involving  a  sale,  in  the  proper  sense  of  the  word,  and 
a  loan  of  the  capital  represented  by  the  goods  sold. 


FINANCIAL   INSTITUTIONS:    THE   BANK  283 

5.  Lenders  intrust  the  control  of  their  capital  only  to  those 
who  have  ''credit'';  that  is,  reputation  for  honesty  and 
ability  to  meet  their  financial  obligations. 

It  is,  of  course,  obvious  that  loans,  whether  productive 
or  consumer's,  will  be  made  only  to  persons  who  have 
"credit" ;  that  is, to  persons  who  are  regarded  as  sufficiently- 
honorable  and  efficient  to  be  willing  and  able  to  repay  the 
sums  loaned  when  they  fall  due.  A  man's  credit  may  rest 
upon  his  reputation  for  personal  integrity  and  business  ca- 
pacity ;  more  commonly  it  rests,  in  part  at  least,  upon 
the  fact  that  he  has  property  which,  under  the  law,  can  be 
seized  by  his  creditors  in  case  of  default  in  payment  of  his 
debts. 

There  are  some  writers  on  economics  who  regard  credit 
as  a  mysterious  productive  instrument,  a  form  of  capital,  or 
at  any  rate  a  substitute  for  capital.  The  illustration  given 
in  section  4  shows  that  this  view  has  no  justification.  What 
the  farmer  cuts  his  wheat  with  is  a  capital  good,  embodying 
capital  furnished  either  by  his  neighbor  or  by  the  agricul- 
tural implement  company.  This  capital  existed  before  the 
farmer  gained  possession  of  it,  and  would  doubtless  have 
been  employed  productively  by  other  persons  if  the  farmer 
had  not  decided  to  buy  a  machine.  The  fact  that  he  buys  the 
machine  with  borrowed  capital  shows  that  he  believes  that 
.he  can  make  this  capital  yield  more  than  the  interest  which 
he  must  pay  for  its  use.  His  "  credit  "  enables  him  to  pro- 
cure capital  to  use  in  an  employment  which  he  believes  to 
be  superior  to  the  average  in  productivity.  If  he  is  right 
in  his  opinion,  he  is  able  to  keep  for  himself  a  part  of  the 
product  of  this  capital,  as  a  profit.  But  the  profit  is  not 
produced  by  his  credit,  any  more  than  the  wheat  is  cut 
by  it. 

6.  A  document  in  which  the  claim  of  the  lender  upon  the 
borroiver  is  reduced  to  written  form  is  known  as  a  credit  in- 
strument.    If  the  claim  thus  reduced  to  writing  can  be  sold 


284  INTRODUCTION   TO   ECONOMICS 

and  purchased,  it  is  knozvn  as  a  negotiable  credit   instri^ 
Dient. 

The  contract  between  the  lender  and  the  borrower  is 
sometimes  merely  verbal,  and  rests  for  its  fulfillment  upon 
the  honor  of  the  borrower.  In  a  larger  number  of  cases, 
the  lender  enters  the  sums  due  him  upon  his  books,  and 
claims  thus  entered  are  usually  collectible  through  the 
courts.  This  is  the  common  form  of  loans  effected  under 
the  guise  of  credit  sales.  The  creditor  may  draw  up  a 
form  instructing  the  debtor  to  pay  the  sum  due  at  a  speci- 
fied time.  Such  an  instrument  is  known  as  a  "  draft  "  or 
"  bill  of  exchange."  The  borrower  may,  at  the  time  of 
raising  the  loan,  sign  a  form  which  specifies  the  terms  of 
the  contract.  Such  an  instrument  is  known  as  a  "promis- 
sory note."  The  borrower  may  specify,  along  with  the 
general  terms  of  the  contract,  certain  property  belonging 
to  him  upon  which  the  creditor  will  have  a  special  claim  in 
case  of  default  in  payment.  A  note  thus  accompanied  by 
the  pledge  of  property  is  commonly  known  as  a  "  mortgage." 

The  claim  of  a  creditor  upon  his  debtor  is  regarded  in 
law  as  a  form  of  property,  and  may  ordinarily  be  purchased 
and  sold  like  any  other  form  of  property.  Claims  repre- 
sented by  promissory  notes,  due  bills,  and  bills  of  exchange 
are  very  frequently  purchased  and  sold,  or  "  negotiated." 
They  are  therefore  called  "negotiable  credit  instruments," 
or  simply,  "  negotiable  paper."  Transfer  of  such  instru- 
ments is  commonly  effected  by  indorsement ;  that  is,  the 
original  claimant  signs  an  order  upon  the  back  of  the 
instrument,  instructing  the  debtor  to  pay  the  sum  due  to 
a  third  party  named  in  the  order. 

7.  Under  modem  conditions  there  is  a  demand  for  and  a 
supply  of  loanalde  capital  for  sJiort  periods  of  indefiiiite  dura- 
tion, for  short  terms  and  for  long  terms.  Corresponding 
with  these  conditions  are  call  or  demand  loans,  short  term 
loans  and  long  term  loans. 


FINANCIAL   INSTITUTIONS:    THE   BANK  285 

Capital  loans  display  wide  variation  in  the  length  of 
time  for  which  the  lender  surrenders  control  of  his  capital. 
Sometimes  the  lender  retains  the  right  of  calling  for  his 
capital  at  any  time  he  desires.  Such  a  loan  is  known  as  a 
"call"  or  "demand"  loan.  Sometimes  the  date  when  the 
debt  falls  due  is  fixed  at  thirty,  sixty,  or  ninety  days.  Such 
a  loan  is  known  as  a  short  term  loan.  Sometimes  the 
loan  runs  for  five,  ten,  or  fifty  years.  In  this  case  the  loan 
may  be  called  a  long  term  loan.  This  variation  in  the  life 
period  of  loans  is  a  reflection  of  the  economic  situation  of 
the  various  classes  of  lenders  and  borrowers. 

At  any  given  time  there  are  men  who  have  more  capital 
than  they  need  immediately  ;  they  cannot  tell,  however, 
how  soon  they  may  need  all  they  have.  On  the  other 
hand,  there  are  men  who  can  use  capital  profitably  for  an  in- 
definite period  of  time,  who  can  yet  return  it  to  its  owner 
whenever  it  is  demanded.  Thus  a  man  who  deals  in  stocks 
and  bonds  may  find  exceedingly  profitable  employment  for 
capital  in  the  purchase  of  such  securities  when  prices  are 
rising.  If  he  is  operating  with  borrowed  capital,  he  can 
sell  the  securities  at  any  time  when  payment  is  demanded, 
and  so  restore  the  capital  to  its  owner. 

Again,  there  are  men  who  can  safely  part  with  the  con- 
trol of  their  capital  for  a  definite  period  of  time  —  say,  from 
one  to  six  months.  Corresponding  with  this  class  of  lenders 
is  a  class  of  borrowers  who  cannot  agree  to  pay  off  a  loan  on 
demand,  but  who  are  able  to  make  arrangements  for  payment 
at  a  definite  date  some  weeks  or  months  after  borrowing 
the  capital.  The  merchant  will  serve  as  a  type  of  this 
class.  He  can  safely  purchase  a  stock  of  goods  with  the 
proceeds  of  a  three  months'  loan,  feeling  quite  sure  that 
within  the  three  months  he  will  be  able  to  sell  the  goods 
and  so  gain  possession  of  the  means  of  repayment. 

Finally,  there  is  a  class  of  lenders  who  have  no  desire 
for  the  early  repayment  of  their  capital.     With  satisfactory 


286  INTRODUCTION  TO   ECONOMICS 

arrangement  made  as  to  the  rate  of  interest  to  be  paid,  they 
may  be  wiHing  to  transfer  control  of  their  capital  for  a  period 
of  ten,  twenty,  or  fifty  years.  There  is  a  corresponding 
class  of  borrowers,  who  desire  capital  for  investment  in 
land,  buildings,  and  permanent  equipment,  and  who  would 
be  greatly  embarrassed  by  the  necessity  of  early  payment. 

There  are,  then,  three  distinguishable  sources  of  supply 
of  loanable  capital,  and  three  corresponding  sources  of  de- 
mand for  it.  In  practical  Hfe,  of  course,  with  highly  de- 
veloped financial  institutions,  there  is  a  certain  degree  of 
interchangeability  in  the  different  funds  of  capital.  Let  us 
suppose  that  lenders  of  the  first  class  place  their  capital 
in  a  bank,  reserving  the  right  of  withdrawingit  at  any  time. 
Experience  shows  that  while  some  lenders  withdraw  their 
capital  each  day,  new  lenders  will  each  day  offer  capital 
at  the  bank.  Thus  the  bank  has  a  permanent  fund  of 
capital  which  it  may  lend  to  business  men  for  stated  periods 
of  time.  Men  who  wish  to  lend  their  capital  for  long 
periods  of  time  may  place  it  with  a  bank,  which  may  use 
it  in  short  term  loans,  experience  showing  that  when  one 
business  man  repays  a  loan  of  this  kind  another  will  be 
ready  to  borrow  the  capital. 

8.  The  principal  functions  of  tJic  bank  are  the  collection 
of  funds  of  loanable  capital  that  are  available  for  short 
periods  only,  and  the  employment  of  such  funds  in  call  and 
short  term  loans. 

The  bank  proper  is  chiefly  engaged  in  providing  business 
men  with  demand  and  short  term  loans.  The  capital  em- 
ployed in  this  way  is  in  part  the  bank's  own,  and  is  perma- 
nently devoted  to  the  purpose.  By  far  the  greater  part  of 
the  capital,  however,  is  suppHed  by  other  persons,  who  loan 
their  surplus  funds  to  the  bank,  receiving  for  its  use 
either  interest  or  some  other  form  of  compensation.  Provi- 
sion for  long  term  loans  is  usually  made  by  various  other 
financial  institutions,  such  as  the  savings  bank,  the  insur- 


FINANCIAL    INSTITUTIONS:    THE    BANK  287 

ancc  company,  the  investment  company,  and  the  exchanges. 
These  institutions  will  receive  attention  in  the  next  chapter. 
Our  present  concern  is  the  economic  nature  of  the  transac- 
tions in  which  the  bank  proper  is  engaged. 

Let  us  suppose  that  a  bank  is  established  in  a  town  which 
up  to  the  present  has  had  no  similar  institution.  As  the 
bank  has  doubtless  better  means  for  keeping  money  safe 
than  are  to  be  found  elsewhere  in  the  town,  we  may  suppose 
that  many  persons  will  be  glad  to  deposit  with  it  any  money 
which  they  do  not  immediately  need,  reserving  the  privi- 
lege of  withdrawing  it  whenever  they  need  it.  On  pay 
days  salaried  employees  will  deposit  most  of  their  month's 
earnings,  expecting  to  withdraw  the  money  day  by  day  to 
meet  their  current  expenses.  Similarly,  capitalists  will  ^ 
deposit  their  annual  or  semi-annual  interest  receipts,  to  be 
withdrawn  in  like  manner  for  current  expenditures.  Mer- 
chants will  deposit  surplus  cash  which  they  will  not  need 
to  reinvest  in  stock  for  some  days  or  weeks.  Lenders 
whose  loans  have  been  repaid  will  deposit  the  money  until 
they  find  another  satisfactory  opportunity  for  lending. 
Thus  a  great  part  of  the  community  will  use  the  bank  in 
greater  or  less  degree  for  the  storing  of  surplus  funds.  The 
sums  so  deposited  are  credited  to  the  depositors  on  the 
books  of  the  bank. 

The  use  of  checks,  or  written  orders  for  the  transfer  of 
funds,  greatly  increases  the  usefulness  of  the  bank  as  a  re- 
pository of  funds  of  this  kind.  The  depositor,  instead  of 
going  in  person  to  the  bank  to  withdraw  money  for  a  pur- 
chase, may  give  a  check  for  the  sum  involved  in  the  trans- 
action. The  recipient  of  the  check  may  present  it  at  the 
bank  for  payment,  carrying  away  the  sum  in  money.  If 
he  is  in  the  habit  of  depositing  his  own  surplus  funds  in 
the  bank,  he  is  more  Hkely  to  deposit  the  check,  instead  of 
cashing  it.  The  sum  called  for  in  the  check  is  then  trans- 
ferred, on  the  books  of  the  bank,  from  the  account  of  the  one 


2S8  INTRODUCTION   TO   ECONOMICS 

person  to  the  account  of  the  other.  Thus  payment  is  effected 
without  the  handling  of  money  by  any  one.  When  the  check 
system  is  well  developed  funds  deposited  with  the  bank  may 
change  owners  scores  of  times  without  ever  leaving  the 
vaults. 

The  cash  intrusted  to  the  bank  may  amount  to  a  very 
considerable  sum.  At  one  time  such  deposits  may  aggre- 
gate ;^50,ooo,  at  another  time  ^75,000.  Experience  may 
show  that  the  volume  of  deposits  never  falls  below  1^40,000. 
This  sum  of  $40,000  may  be  regarded  as  a  perpetual  fund 
intrusted  to  the  bank  by  the  body  of  depositors,  although 
actual  ownership  of  each  part  of  it  is  continually  changing. 

The  bank  is,  of  course,  under  no  obligation  to  keep  in  its 
vaults  the  money  that  has  thus  been  intrusted  to  it.  All 
that  the  bank  is  required  to  do  is  to  hold  itself  in  readiness 
to  pay  the  money  on  demand.  So  long  as  it  does  this,  it 
may  use  the  deposits  in  any  way  that  it  may  find  profitable 
—  observing,  of  course,  such  restrictions  in  the  use  of  its 
funds  as  the  law  prescribes.  And  this  fact  indicates  the 
economic  nature  of  such  deposits.  They  are  loans,  payable 
on  demand,  the  depositor  being  the  creditor,  the  bank  the 
debtor. 

Up  to  the  present  point  we  have  been  concerned  with 
the  bank  as  a  borrower  of  capital.  We  have  now  to  con- 
sider its  position  as  a  lender  of  capital.  Let  us  suppose 
that  one  of  the  inhabitants  of  the  town  is  a  manufacturer 
of  hardware,  who  sells  his  products  "on  time  "  to  jobbers. 
This  manufacturer  has  sold,  let  us  say,  $10,000  worth  of 
products,  receiving  in  lieu  of  payment  notes  for  $10,000  at 
three  months'  time.  This  means,  as  we  have  already  seen, 
that  the  manufacturer  has  made  a  disguised  loan  of  capi- 
tal to  the  jobbers.  The  manufacturer,  however,  needs'his 
capital  in  order  to  continue  his  business  of  manufacture. 

He  may,  if  his  credit  is  good,  borrow  $10,000  from  the 
bank,  agreeing  to  repay  the  loan  in  three  months.     When 


FINANCIAL   INSTITUTIONS:    THP:    BANK  289 

his  debt  falls  due,  the  notes  of  the  jobbers  will  also  fall 
due ;  accordingly,  he  will  find  himself  in  an  excellent  posi- 
tion to  cancel  his  debt.  Other  business  men  will  borrow 
from  the  bank  under  similar  conditions  as  large  a  portion 
of  the  capital  deposited  with  the  bank  as  can  safely  be 
loaned.  When  one  set  of  borrowers  repays  the  sums  bor- 
rowed from  the  bank,  another  set  can  easily  be  found. 
Thus  the  bank  has  a  permanent  volume  of  loans,  as  well  as 
a  permanent  volume  of  deposits,  although  the  borrowers, 
like  the  depositors,  are  continually  dropping  out  and  being 
replaced  by  others. 

9.  A  bank  loan  may  be  regarded  as  the  purcJiase  of  a 
credit  instrument,  such  as  a  promissory  note  or  bill  of  ex- 
change. 

In  the  foregoing  section  it  was  assumed  that  men  who 
wish  to  secure  capital  from  a  bank  borrow  it  directly ;  and 
this,  indeed,  is  often  the  case.  When  a  business  man  bor- 
rows for  the  purpose  of  recovering  the  control  of  capital 
which  he  has  loaned,  under  the  form  of  a  sale  to  other 
persons,  he  is  more  likely  to  take  the  notes  received  from 
the  latter  to  the  bank  for  sale.  If  the  notes  bear  no  inter- 
est, the  bank,  in  purchasing  them,  will  deduct  from  their 
face  value  interest  for  the  time  that  will  elapse  before  the 
notes  "  mature,"  or  fall  due.  This  process  of  deducting 
interest  in  advance  is  known  as  "  discounting."  In  the 
language  of  the  banking  business,  the  purchase  of  a  note 
is  commonly  spoken  of  as  the  discounting  of  a  note,  and 
notes  purchased  are  called  "discounts."  Discounts  are 
evidently  nothing  but  loans. 

When  a  person  desires  to  borrow  capital  from  a  bank, 
he  offers  his  own  note,  which  the  bank  usually  discounts  in 
the  manner  described  above.  We  may  think  of  the  borrower 
as  offering  his  own  note  to  the  bank  for  sale.  Thus  the 
whole  volume  of  bank  loans  may  be  regarded  as  invest- 
ments in  credit  instruments. 


?90 


INTRODUCTION   TO    ECONOMICS 


10.  A  bank  must  invest  funds  intrusted  to  it  in  such  a 
way  that  it  can  quickly  regain  possession  of  such  funds  if 
necessary. 

While  the  volume  of  funds  intrusted  to  a  bank  may, 
under  ordinary  circumstances,  remain  fairly  constant,  ow- 
ing to  the  fact  that  new  deposits  offset  withdrawals,  it 
would  be  unwise  for  the  managers  of  a  bank  to  invest  such 
deposits  in  ways  that  would  make  early  payment  of  de- 
positors impossible.  At  any  time  depositors  may  lose 
confidence  in  the  stability  of  a  bank  and  demand  the  sums 
due  them.  Let  us  suppose  that  such  a  panic  of  the  de- 
positors or  "run  on  the  bank"  occurs,  and  that  the  bank 
has  invested  the  funds  intrusted  to  it  in  suburban  real 
estate.  Such  property  may  not  be  salable,  and  all  the 
bank  can  do  is  close  its  doors  until  such  time  as  it  can 
dispose  of  its  real  estate  holdings  and  pay  off  its  deposi- 
tors. This  would,  of  course,  mean  the  ruin  of  the  bank, 
even  though  the  real  estate  sold  eventually  at  an  advance. 

The  bank  may  invest  the  funds  deposited  with  it  in 
government  bonds.  These  always  find  a  market,  but 
their  price  fluctuates,  and  the  bank  might  incur  some  loss 
in  disposing  of  its  holdings  in  order  to  meet  the  pressing 
demands  of  its  depositors.  Moreover,  such  bonds  yield  a 
very  low  rate  of  interest. 

The  notes  that  are  created  in  ordinary  commercial  trans- 
actions are  one  of  the  most  satisfactory  forms  of  bank 
investments.  They  are  usually  drawn  for  brief  terms  — 
thirty,  sixty,  or  ninety  days  —  and  such  notes  are  usually 
given  in  payment  for  goods  which  are  salable  in  a  rea- 
sonable time.  Thus  there  is  reason  for  believing  that  such 
notes  can  be  met  when  due.  If  the  depositors  of  a  bank 
press  for  payment,  so  that  the  bank  cannot  await  the 
maturity  of  the  notes  it  holds,  it  can  usually  sell  them  to 
other  banks  and  thus  secure  the  means  of  immediate  pay- 
ment. 


FINANCIAL   INSTITUTIONS:    THE   BANK  291 

In  the  United  States  national  banks  are  limited  by  law 
to  such  investments  as  short  term  notes,  bills  of  exchange, 
and  government  bonds.  Investments  in  real  estate,  ex- 
cept for  use  in  connection  with  the  business  operations  of 
the  bank,  are  prohibited.  State  banks  are  also  more  or 
less  narrowly  restricted  in  their  investments, 

11.  Under  modern  conditions  the  greater  part  of  the  vol- 
nme  of  bank  deposits  arises  out  of  the  process  of  making 
loans. 

It  has  been  assumed,  in  the  foregoing  sections,  that  the 
principal  business  of  a  bank  is  the  lending  of  deposits 
intrusted  to  it  in  the  form  of  spare  cash.  It  is  only  under 
simple  conditions  that  this  -is  a  fair  representation  of  the 
business  of  a  bank.  In  a  modern  industrial  and  commercial 
city  the  deposits  of  cash  represent  a  very  small  part  of  the 
volume  of  deposits  that  figure  on  the  books  of  a  bank. 

Let  us  suppose  that  a  bank  commences  business  with  a 
capital  of  ;^  100,000,  consisting  entirely  of  cash.  Part  of 
this  sum  —  say  $5000  —  is  spent  in  acquiring  a  suitable 
building.  The  remaining  $95,000  is  held  in  the  safe  of 
the  bank,  to  be  loaned  to  business  men  who  can  offer 
adequate  security. 

A  manufacturer  offers  at  the  bank  acceptable  notes 
amounting  to  $10,000,  and  gets  them  discounted.  He 
may,  if  he  chooses,  carry  away  with  him  the  cash  repre- 
sented by  the  discounted  value  of  the  notes.  This,  how- 
ever, he  is  not  likely  to  do.  What  he  wants  the  money 
for  is  to  make  purchases  of  materials,  to  pay  salaries  and 
wages,  and  to  meet  other  business  expenses.  The  most 
convenient  method  of  payment  is  by  checks  drawn  on  the 
bank.  So  instead  of  carrying  the  money  away  from  the 
bank  he  is  likely  to  leave  it  as  a  deposit,  subject  to  with- 
drawal on  demand.  Of  course  there  is  no  reason  why  the 
bank  should  go  through  the  form  of  counting  out  the  cash 
to  the  manufg.cturer  if  it  is  to  be  redeposited  in  this  way. 


292 


INTRODUCTION   TO   ECONOMICS 


What  it  does  is  to  credit  the  manufacturer  with  a  "  deposit  *' 
equal  to  the  discounted  value  of  the  notes  which  he  has 
transferred  to  it. 

Let  us  follow  in  imagination  the  history  of  the  manu- 
facturer's deposit.  In  the  course  of  a  month  he  may  draw 
checks  aggregating  a  sum  equal  to  the  deposit  credited  to 
him  in  payment  of  wages  and  other  expenses.  These 
checks  may  be  deposited  with  the  bank  by  the  manufac- 
turer's employees  and  the  merchants  who  furnish  materials 
and  other  supplies.  The  employees  and  merchants  draw 
checks  upon  the  bank  to  cover  their  expenses,  but  these 
checks  may  be  redeposited.  It  is  possible  that  the  notes 
originally  discounted  will  fall  due  and  be  paid  before  the 
bank  is  compelled  to  surrender  any  considerable  amount  of 
cash  on  account  of  the  loan  which  it  made  in  discounting 
the  notes. 

Let  us  suppose  that  the  bank  has  discounted  notes 
amounting  to  $95,000  —  a  sum  equal  to  its  original  cash 
holdings.  In  discounting  these  notes  the  bank  has  credited 
its  customers  with  deposits  amounting,  we  will  say,  to 
$94,000.  As  these  deposits  are  drawn  upon,  the  checks 
drawn  are  largely  deposited  with  the  bank  under  other 
accounts.  Very  likely  not  more  than  $4000  out  of  the 
$94,000  in  deposits  is  withdrawn  from  the  bank  in  the 
form  of  cash.  We  see,  then,  that  if  the  bank  were  to 
limit  its  loans  to  the  amount  of  cash  actually  on  hand,  the 
greater  part  of  this  cash  would  remain  in  the  bank  idle. 

Accordingly,  it  is  natural  that  the  bank  should  try  to  get 
a  return  from  its  cash  by  making  additional  loans.  If  it 
lends  $200,000  on  a  basis  of  $95,000  in  cash,  crediting  the 
borrowers  with  deposits  amounting  to  $195,000,  the  chances 
are  that  a  larger  amount  of  cash  will  be  withdrawn  by 
depositors  than  if  its  loans  amounted  to  $95,000  and  the 
deposits  to  $94,000.  Yet  the  withdrawals  of  cash  may 
amount  to  only  $15,000,  leaving  the  bank  still  with  a  large 


FINANCIAL   INSTITUTIONS:    THE    BANK  293 

amount  of  idle  cash.  It  can  safely  increase  the  volume  of 
its  loans  and  the  resultant  deposits.  As  the  volume  of 
deposits  increases,  a  point  must  eventually  be  reached 
where  the  cash  on  hand  is  just  sufficient  to  meet  all  prob- 
able demands  for  cash.  At  this  point  the  bank  must  cease 
to  make  further  loans. 

12.  Every  bank  receives  in  the  course  of  its  business  checks 
drawn  upon  other  banks.  Through  the  clearing  system  the 
checks  received  by  a  bank  are  bahinced  against  checks  drawn 
upon  it  and  deposited  ivitJi  other  banks,  so  that  little  cash  is 
zuitJidrawn  from  it  in  the  settlement  of  claims  of  otJier 
banks. 

One  reason  why  a  bank  can  extend  its  loans  far  beyond 
the  volume  of  the  cash  in  its  possession  is  that  checks 
drawn  upon  it  are  likely  to  be  deposited  with  it,  instead  of 
being  cashed.  If  checks  drawn  upon  one  bank  are  de- 
posited with  another  bank,  withdrawal  of  cash  would 
appear  to  be  inevitable,  since  one  bank  does  not,  except 
under  special  circumstances,  keep  a  deposit  with  another 
bank. 

Let  us  assume  that  in  a  town  there  are  several  banks 
which  we  may  designate  as  A,  B,  C,  etc.  Some  of  the 
citizens  of  the  town  will  deposit  their  funds  with  bank  A, 
some  with  B,  some  with  C.  Often  a  man  will  use  his 
check,  drawn  on  bank  A,  in  making  a  payment  to  a  man  who 
keeps  his  deposit  with  bank  B  or  C.  The  recipient  of  the 
check  might  of  course  take  the  check  to  bank  A,  obtain 
cash  for  it,  and  deposit  the  money  with  his  own  bank.  It  is 
more  convenient,  however,  for  him  to  transfer  the  check, 
by  indorsement,  to  his  own  bank.  The  bank  then  credits 
him  with  the  sum  represented  by  the  check,  and  assumes 
the  trouble  of  collecting  the  sum  from  bank  A.  And 
so  every  day,  we  may  suppose,  checks  drawn  on  bank  A 
are  deposited  with  banks  B  and  C ;  checks  drawn  on 
these  banks  are  deposited  with  bank  A.     At  the  end  of 


294  INTRODUCTION   TO   ECONOMICS 

each  business  day  a  clerk  in  the  employ  of  bank  A  takes  the 
checks  drawn  on  B  and  C  and  presents  them  for  payment 
at  those  banks.  Similarly  a  clerk  from  bank  B  presents 
for  payment  checks  deposited  with  that  bank,  drawn  upon 
A  and  C,  One  can  easily  see  that  such  a  method  of  settle- 
ment involves  some  waste  of  energy.  While  a  clerk  of 
bank  A  is  presenting  for  payment  at  bank  B  checks  drawn 
upon  that  bank,  a  clerk  of  bank  B  is  presenting  for  pay- 
ment at  bank  A  checks  drawn  upon  the  latter  bank. 
Money  is  being  carried  from  A  to  B  at  the  same  time  that 
money  is  carried  from  B  to  A.  Obviously  some  method  of 
balancing  can  be  devised  which  will  save  the  unnecessary 
labor  and  risk  of  thus  carrying  money  to  and  fro.  Espe- 
cially would  this  be  necessary  in  a  large  city,  where  there 
are  scores  of  banks. 

In  every  important  center  the  banks  form  an  association 
which  provides  a  building  or  a  hall  known  as  a  clearing 
house,  where  representatives  of  the  several  banks  meet  daily 
for  the  settlement  of  the  claims  of  each  bank  upon  the  other 
banks.  The  claims  of  each  bank  upon  all  the  others  are  set 
off  against  the  claims  of  all  the  other  banks  upon  it.  When 
this  has  been  done,  it  will  be  found  that  some  of  the  banks 
have  a  balance  in  their  favor,  while  others  have  a  deficit  to 
make  good.  Each  debtor  bank  then  pays  a  single  lump 
sum  representing  its  indebtedness  to  all  the  associated 
banks ;  each  creditor  bank  receives  a  lump  sum  represent- 
ing the  balance  of  its  claims  upon  all  the  banks.  By  this 
method  the  transfer  of  cash  from  bank  to  bank  is  reduced 
to  the  lowest  terms. 

13.  TJie  cash  kept  on  hand  by  a  bank  to  meet  probable 
cash  demands  is  k?to%un  as  the  reserve.  In  many  cases  the 
laivs  regulating;  banking  require  the  banks  to  maintain  re- 
serves amounting  to  a  certain  proportion  of  the  deposits  and 
other  demand  liabilities. 

If  banks  are  free  to  extend  their  loans  at  will,  the  amount 


FINANCIAL   INSTITUTIONS:    THE   BANK  295 

of  cash  kept  on  hand  to  meet  the  possible  demands  of  the 
depositors  will  vary  according  to  the  banking  habits  of  the 
business  community  and  the  temperament  of  the  bankers. 
In  highly  developed  commercial  communities,  very  little 
cash  is  used  in  effecting  exchanges ;  reliance  is  placed 
upon  the  use  of  checks.  In  such  a  community  a  bank 
may  extend  its  loans,  and  the  attendant  volume  of  its  de- 
posits, almost  without  definite  limit.  If  it  keeps  on  hand 
$10  in  cash  for  every  $100  of  deposits,  it  will  probably  be 
able  to  meet  all  cash  demands  without  difificulty.  Banks 
have  been  known  to  conduct  a  successful  business  with 
only  $5  in  reserve  for  every  $100  of  deposits. 

The  smaller  the  proportion  of  the  reserve  to  the  de- 
posits, however,  the  greater  the  chance  that  a  bank  will 
be  unable  to  meet  demands  for  cash  from  its  depositors 
and  other  creditors.  Failure  to  meet  such  demands  may 
cause  great  embarrassment  to  the  customers  of  the  bank. 
If  a  man  cannot  draw  upon  his  bank  deposit,  very  likely 
he  will  be  unable  to  meet  his  own  obligations  ;  his  creditors, 
in  turn,  are  embarrassed  in  meeting  their  obligations,  and 
so  the  evil  extends  in  ever  widening  circles  throughout  the 
business  community.  The  depositors  of  other  banks,  fear- 
ing that  their  banks  will  likewise  fail  to  pay  cash  on  de- 
mand, withdraw  their  deposits  until,  at  times,  it  becomes 
impossible  for  those  banks  to  continue  to  pay  cash. 

It  is  natural  that  legislatures  should  attempt  to  reduce 
the  chances  of  such  a  calamity  by  regulating  the  business 
of  the  banks.  A  favorite  device  is  to  fix  by  law  a  mini- 
mum reserve  to  be  maintained  by  each  bank  against  its 
deposits.  In  the  United  States,  banks  organized  under 
federal  laws  are  required  to  keep  reserves  amounting  to 
fifteen  per  cent  of  the  deposits  in  the  lesser  cities,  and  to 
twenty-five  per  cent  of  the  deposits  in  the  larger  cities. 
Banks  organized  under  state  laws  are  required  to  keep  re- 
serves amounting  to  from  ten  to  twenty-five  per  cent. 


296  INTRODUCTION    TO    ECONOMICS 

14.  The  chances  of  ultimate  loss  to  the  depositor  of  a  well 
conducted  bank  are  very  small. 

It  may  seem  that  even  when  a  bank  keeps  a  reserve 
amounting  to  twenty-five  per  cent  of  its  deposits,  the  deposi- 
tor is  in  danger  of  loss.  What  if  more  than  twenty-five  per 
cent  of  the  deposits  should  be  demanded  on  any  one  day  } 
The  bank  would,  of  course,  be  unable  to  make  payment 
immediately. 

If  a  bank  is  not  grossly  mismanaged,  it  has  property 
worth  at  least  one  dollar  for  every  dollar  figuring  in  its 
deposits.  When  it  makes  a  loan  of  $10,000,  thus  creating 
a  deposit  amounting,  we  will  say,  to  $9700,  it  receives 
from  the  borrower  notes  amounting  to  $10,000,  which 
must  be  set  against  the  $9700  which  it  owes  its  depositors. 
If  the  notes  are  good,  at  their  maturity  the  bank  will  re- 
ceive more  than  enough  cash  to  cancel  the  deposits  created 
when  the  loan  was  made.  Every  part  of  the  volume-  of 
deposits  is  covered  in  this  way  by  notes,  bills  of  exchange, 
etc.,  in  the  vault  of  the  bank. 

These  notes,  etc.,  usually  run  for  short  periods,  seldom 
extending  over  six  months,  and  frequently  maturing  in  less 
than  thirty  days.  Even  if  the  bank  fails  to  meet  its  obliga- 
tions on  demand,  the  worst  that  the  depositor  usually  has 
to  fear  is  that  he  will  have  to  wait  some  weeks  or  months 
until  the  bank  can  collect  the  sums  due  it. 

But  suppose  that  the  notes  in  the  bank's  vaults  are  worth- 
less; that  the  bank  will  be  unable  to  collect  the  sums  due. 
In  that  case,  the  bank's  own  capital  must  be  used  to  meet 
the  claims  of  the  depositors.  If  the  volume  of  worthless 
notes  exceeds  the  amount  of  the  bank's  capital,  then  the 
depositor  may  suffer  loss. 

It  is,  however,  rarely  the  case  that  a  bank  discounts  any 
large  number  of  worthless  notes.  A  bank  accepts  only 
such  notes  as  there  is  reason  to  believe  are  good.  Bank 
officials  are  in  an  excellent  position  to  judge  of  the  business 


FINANCIAL    INSTITUTIONS:    THE    BANK  297 

staijding  of  the  bank's  customers.  Checks  used  by  these 
customers  in  payment  of  their  obligations  pass  through  the 
bank;  checks  received  by  them  are  deposited  with  the  bank. 
Thus  it  becomes  fairly  easy  for  competent  bank  officials  to 
ascertain  whether  a  business  man  is  prospering,  or  operating 
at  a  loss.  In  the  latter  case,  the  bank  forces  the  payment 
of  notes  when  due,  and  refuses  to  make  new  loans.  Thus 
bank  loans  are,  as  a  rule,  restricted  to  those  members  of 
the  business  community  who  are  able  to  keep  themselves 
in  a  position  to  pay  their  debts. 

In  some  instances,  to  be  sure,  banks  are  ruined  through 
fraud.  Bank  officials  may  embezzle  the  funds  or  may 
extend  loans  to  personal  friends  to  be  employed  in  risky 
ventures  which  result  in  total  loss.  The  laws  of  most 
states  are  stringent  enough  to  reduce  losses  through  fraud 
to  a  minimum. 

15.  Bank  notes  are  claims  upon  the  bank  tJiat  are  essen- 
tia//}' of  t/ie  same  nature  as  deposits. 

In  the  foregoing  discussion  it  has  been  assumed  that  the 
transfer  of  claims  upon  the  bank  is  made  through  checks, 
drawn  upon  a  deposit,  and  redeposited  by  the  holder.  A 
man  who  receives  a  check  may,  however,  transfer  it,  prop- 
erly indorsed,  to  another  man,  who  in  turn  may  transfer 
the  check  to  a  third  person.  Each  holder  of  the  check 
becomes  in  turn  the  creditor  of  the  bank.  When  the  check 
is  at  last  deposited  with  the  bank,  the  claim  upon  the  bank 
is  formally  transferred  on  its  books.  But  it  is  obvious  that 
the  claim  on  the  bank  is  just  as  certainly  transferred  when- 
ever the  check  changes  hands. 

Such  a  check  could  not  pass  through  many  hands,  be- 
cause only  those  persons  knowing  the  credit  of  the  drawer 
would  be  willing  to  accept  it.  There  are  men  who  draw 
checks  on  banks  where  they  keep  no  deposit;  if  you  are 
offered  a  check  drawn  by  some  one  you  have  never  heard  of, 
how  do  you  know  that  it  will  be  honored  by  the  bank? 


298  INTRODUCTION   TO    ECONOMICS 

A  person  wishing  to  use  checks  as  a  means  of  payment 
among  persons  who  are  not  certain  of  his  credit  may  take 
the  checks  to  the  bank  and  have  the  cashier  certify  upon 
their  face  that  they  represent  a  deposit,  and  will  be  honored 
by  the  bank.  Such  checks  —  known  as  certified  checks  — 
may  circulate  as  freely  as  money  in  the  community  where 
the  bank's  standing  is  known.  It  is  clear,  however,  that  a 
certified  check  is  a  claim  upon  the  bank  of  the  same  nature 
as  an  ordinary  check  drawn  upon  a  deposit. 

Instead  of  certifying  checks  drawn  upon  a  deposit,  the 
bank  may  give  the  customer  who  wishes  means  of  ready 
payment  a  parcel  of  its  own  notes,  payable  to  the  bearer  on 
demand.  The  customer  is  then  the  creditor  of  the  bank 
for  the  amounts  stated  in  the  bank  notes  in  his  possession. 
As  soon  as  he  uses  the  notes  for  the  purchase  of  supplies, 
etc.,  he  transfers  the  claim  upon  the  bank  to  the  seller  of 
the  supplies.  Such  notes  may  pass  from  hand  to  hand  for 
years,  each  successive  holder  of  a  note  becoming  the  cred- 
itor of  the  bank. 

Obviously  it  makes  Httle  difference  to  the  bank  whether 
a  business  man  who  discounts  a  note  is  credited  with  a  de- 
posit on  the  books  of  the  bank  or  takes  the  bank's  notes  in 
the  same  sum.  The  deposit  represents  a  right  to  cash 
on  demand  ;  the  bank  notes  represent  exactly  the  same 
thing.  The  deposit  may  pass  from  owner  to  owner  through 
checks  drawn  upon  it  and  redeposited  with  the  bank ;  the 
note  passes  from  owner  to  owner  without  the  formaUty  of 
a  transfer  on  the  books  of  the  bank.  Any  one  of  the  series 
of  owners  of  the  deposit  may  demand  cash  at  any  time  ;  the 
same  is  true  of  any  one  of  the  series  of  holders  of  a  bank 
note.  For  some  classes  of  transactions,  it  is  true,  a  deposit 
subject  to  check  is  the  more  convenient  means  of  payment, 
while  for  other  classes  of  transactions  bank  notes  are  the 
more  convenient. 

16.     TJie  issue  of  bank  notes  is  usually  hedged  about  by 


FINANCIAL    INSTITUTIONS:    THE    BANK  299 

legal  restrictions  designed  to  protect  the  note  holder  from 
loss. 

The  issue  of  bank  notes  is  usually  carefully  regulated 
by  government,  so  as  to  safeguard  the  holder  of  notes 
against  loss.  Now,  we  have  seen  that  the  positions  of  the 
note  holder  and  the  depositor  are  analogous.  Both  are 
creditors  of  the  bank  ;  both  have  a  right  to  cash  on  de- 
mand. Why  then  should  the  government  take  greater  pains 
to  insure  the  note  holder  against  loss  than  to  insure  the 
depositor  ? 

The  depositor  usually  lives  in  the  city  in  which  the 
bank  which  holds  his  funds  on  deposit  is  established.  He 
is  therefore  in  a  position  to  know  something  of  the  standing 
of  the  bank.  If  he  has  reason  to  believe  that  the  bank  is 
not  well  managed,  he  can  at  once  withdraw  his  deposit.  On 
the  other  hand,  bank  notes  often  find  their  way  to  distant 
cities.  The  holders  of  such  notes' can  know  nothing  about 
the  credit  of  the  issuing  bank.  For  this  reason  it  is  only 
just  that  their  interests  should  be  protected  by  the  govern- 
ment. 

Various  methods  are  employed  by  the  different  govern- 
ments to  protect  the  note  holder  against  loss.  In  some 
countries  the  volume  of  notes  that  a  bank  may  issue  is 
limited  to  a  certain  proportion  of  the  capital  of  the  bank ; 
in  case  of  failure  the  note  holders  have  a  prior  claim  upon 
all  the  resources  of  the  bank ;  furthermore,  each  bank  is  re- 
quired to  contribute  to  a  fund  for  the  immediate  payment  of 
notes  of  banks  that  have  failed.  In  the  United  States  the 
privilege  of  note  issue  is  practically  restricted  to  national 
banks;  other  banks  may  indeed  issue  notes,  but  are  taxed  so 
heavily  on  their  notes  that  issue  is  unprofitable.  A  national 
bank  which  avails  itself  of  the  privilege  of  issue  must  pur- 
chase, and  deposit  with  the  United  States  Treasury,  United 
States  bonds  the  par  value  and  the  market  value  of  which  is 
equal  to  the  value  of  the  notes  issued.     In  case  the  bank 


300  INTRODUCTION   TO   ECONOMICS 

fails,  these  bonds  are  sold,  and  the  proceeds  used  to  redeem 
the  notes.  Thus  it  is  quite  impossible  for  the  holder  of 
bank  notes  to  suffer  loss,  even  if  the  bank  of  issue  fails. 

17.  Bank  notes  and  bank  deposits  serve  as  currency,  and 
reduce  the  amount  of  money  needed  for  effecting  exchanges. 

In  the  United  States  bank  notes  are  used  in  effecting 
exchanges  in  the  same  way  that  money  is  used.  Every 
one  knows  that  the  note  holder  is  absolutely  insured 
against  loss ;  consequently  no  one  takes  the  trouble  to 
present  bank  notes  at  the  issuing  bank  for  redemption  in 
money.  Were  the  issue  of  bank  notes  prohibited,  a  large 
volume  of  exchanges  now  effected  through  their  use  would 
have  to  be  effected  by  means  of  money.  We  should  need 
a  much  larger  amount  of  money  than  we  now  possess  to 
carry  on  the  existing  business  of  the  country. 

Bank  deposits  serv^e  in  a  similar  way  as  a  means  of 
effecting  exchanges.  A  deposit,  we  have  seen,  is  not 
a  definite  sum  of  actual  money,  kept  safe  in  the  vaults  of  a 
bank.  It  is  a  right  to  demand  money  at  the  bank.  When  a 
man  pays  for  goods  by  means  of  a  check  drawn  on  such 
a  deposit,  he  simply  transfers  his  claim  upon  the  bank. 
Such  a  claim  may  be  transferred  again  and  again,  effecting 
scores  of  exchanges. 

It  has  been  estimated  that  in  the  great  commercial  cen- 
ters of  the  United  States  fully  ninety-five  per  cent  of  the 
total  volume  of  purchases  and  sales  is  effected  by  means  of 
the  transfer  of  claims  upon  banks.  Money  plays  a  rela- 
tively more  important  part  in  the  lesser  towns  and  the 
rural  districts ;  yet  even  here  it  is  probable  that  bank  notes 
and  deposits  effect  a  larger  volume  of  exchanges  than  does 
actual  money. 

18.  Summary. 

The  principal  function  of  finance  is  the  transfer  of  capi- 
tal to  those  who  can  use  it  most  advantageously.  The 
transfer  of  capital  usually  assumes  the  form   of  a  loan. 


FINANCIAL    INSTITUTIONS:    THE    BANK  301 

either  recognized  as  such,  or  disguised  under  the  form  of  a 
credit  sale.  We  may  look  upon  the  lending  of  capital  as 
the  purchase  of  such  credit  instruments  as  the  promissory 
notes  given  by  borrowers. 

The  function  of  the  bank  is  primarily  the  borrowing  of 
sums  of  capital  available  for  short  periods  of  time  and  the 
investment  of  such  sums  in  short  term  credit  instruments. 
The  sums  borrowed  by  the  bank  are  known  as  "  deposits"; 
the  investments  of  the  bank,  since  they  represent  for  the 
most  part  the  face  value  of  the  credit  instruments  pur- 
chased less  interest  to  maturity,  are  known  as  "  discounts." 
In  practice,  when  a  business  man  sells  a  note  to  a  bank, 
he  leaves  the  proceeds  of  the  note  as  a  "deposit"  in  the 
bank,  subject  to  w'ithdrawal  by  check.  In  modern  banks 
by  far  the  greater  part  of  the  volume  of  deposits  is  created 
in  this  way,  and  not  by  the  deposit  of  cash. 

While  the  bank  is  compelled  to  pay  out  its  deposits  on 
the  demand  of  the  depositor,  it  is  rarely  the  case  that  many 
depositors  demand  cash  at  any  one  time.  This  is  partly 
due  to  the  convenience  of  payment  by  means  of  checks. 
A  depositor  who  wishes  to  make  a  payment  draws  a  check 
in  favor  of  his  creditor  ;  and  this  check  is  likely  to  be 
deposited  in  the  bank  by  the  payee  ;  thus  the  payment  is 
effected  without  any  withdrawal  of  cash  from  the  bank. 
Through  the  system  of  clearing  each  bank  is  protected 
against  serious  drains  upon  its  cash  holdings  through 
checks  drawn  upon  it  and  deposited  in  other  banks. 

While  little  cash  is  ordinarily  withdrawn  from  a  bank, 
under  ordinary  circumstances,  it  is  nevertheless  necessary 
for  a  bank  to  keep  on  hand  a  considerable  amount  of  cash, 
to  safeguard  itself  against  unexpected  demands.  The  cash 
thus  kept  on  hand  is  known  as  the  reserve.  The  amount 
of  the  reserve  should  bear  a  proportion  to  the  deposits 
which  varies  according  to  the  character  of  the  community 
in  which  the  business  is  carried  on.     In  the  United  States 


302 


INTRODUCTION   TO    ECONOMICS 


a  minimum  reserve  is  prescribed  by  law.  The  ultimate 
solvency  of  a  bank  does  not  depend  upon  its  reserve,  but 
upon  the  character  of  the  notes  in  which  the  bank  invests 
its  funds.  These  are,  as  a  rule,  sound,  and  the  chances 
of  bank  failure,  except  through  fraud,  are  small. 

The  notes  issued  by  banks  are  demand  liabilities  not 
essentially  different  from  deposits.  Since  notes  wander 
far  from  the  bank  of  issue  and  are  offered  in  payment  to 
persons  who  can  know  nothing  of  the  credit  of  the  issuing 
bank,  special  regulations  are  adopted  by  governments  to 
insure  their  payment. 

Bank  notes  and  bank  deposit"  fulfill  the  functions  of  cur- 
rency. The  amount  of  money  necessary  for  carrying  on 
exchanges  is  greatly  reduced  by  the  use  of  a  deposit  and 
note  currency. 


CHAPTER   XVII 

OTHER  FINANCIAL  INSTITUTIONS 

1.  TJie  makiJig  of  permanent  and  long  term  investments 
may  be  regarded  as  the  flow  of  funds  from  the  capitalist 
class  to  the  enterpriser  class. 

The  chief  function  of  the  bank,  as  we  have  seen,  is  the 
supplying  of  the  demand  for  short  term  loans,  through  the 
accumulation  and  placing  of  capital  which  is  available  for 
use  for  short  periods  of  time.  The  creditors  of  a  bank 
and  its  debtors  are,  as  a  rule,  members  of  the  same  eco- 
nomic class  —  men  actively  engaged  in  trade  and  industry. 
Each  man  is,  in  turn,  borrower  and  lender.  In  the  pres- 
ent chapter  we  are  concerned  with  the  investment  of  funds 
in  credit  instruments  that  run  for  long  terms,  or  are  per- 
haps even  perpetual.  It  is  plain  that  we  are  here  dealing 
with  the  relations  of  two  fairly  distinct  economic  classes. 
Men  who,  for  one  reason  or  another,  take  no  active  part 
in  business,  place  their  funds  with  active  business  men. 
The  former  class  corresponds  roughly  with  the  capitalistic 
class  of  economic  theory,  the  latter,  with  the  enterpriser 
class.  We  may,  therefore,  regard  the  placing  of  capital  in 
permanent  and  long  term  investments  as  a  flow  of  funds 
from  the  capitalist  to  the  enterpriser. 

2.  TJie  p)  incipal  sources  of  dona nd  for  long  term  invest- 
ment funds  are  ( i )  the  purchase  and  improvement  of  real 
estate  ;  (2)  tJie  financing  of  large  corporations  ;  and  (3)  tJie 
extraordinary  iteeds  of  government. 

Throughout  the  country  there  is  a  constant  demand  for 
capital  for  the  purchase  and  improvement  of  real  estate. 
Men  with  small  capitals  of  their  own  desire  to  buy  farms 
or  building  lots ;  men  who  possess  land  desire  to  prepare 

303 


304  INTRODUCTION   TO   ECONOMICS 

it  for  cultivation  or  to  equip  it  with  the  necessary  stock  oi 
buildings.  Those  with  insufficient  capital  —  and  they  are 
many  —  enter  the  capital  market  as  borrowers.  They  ex- 
pect such  capital  as  they  may  raise  through  loans  to  be 
highly  productive,  but  they  cannot  be  sure  that  they  will 
be  able  to  restore  it  to  the  lenders  for  several  years.  To 
meet  the  needs  of  such  borrowers,  lenders  must  surrender 
control  of  their-  funds  for  a  considerable  period  of  time  — 
five,  ten,  or  fifteen  years. 

A  second  source  of  demand  for  capital  arises  from  the 
needs  of  the  modern  large  scale  business  enterprise.  In 
many  forms  of  business  the  capital  necessary  for  effective 
operation  exceeds  the  amount  that  an  ordinary  enterpriser 
owns,  or  can  raise  through  personal  loans.  The  number 
of  million-dollar  enterprises  in  the  United  States  vastly 
exceeds  the  number  of  millionaires.  Accordingly,  it  is 
necessary  to  transfer  to  a  single  active  enterpriser  the 
capitals  accumulated  by  numerous  individuals. 

A  third  source  of  demand  for  capital  — and  the  last  with 
which  we  need  concern  ourselves  —  arises  from  the  extraor- 
dinary needs  of  government.  Under  ordinary  circum- 
stances the  expenditures  of  most  governments  are  met  by 
current  revenues.  Owing  to  unforeseen  circumstances, 
revenues  may  be  less  than  were  anticipated,  while  expen- 
ditures may  prove  unusually  heavy.  As  it  takes  time  to 
revise  a  revenue  system,  a  considerable  deficit  may  appear, 
which  involves  borrowing  under  one  form  or  another. 

A  much  more  important  cause  of  public  borrowing  is  the 
enormous  expense  entailed  by  modern  warfare.  No  great 
war  can  be  carried  to  a  successful  issue  without  the  em- 
ployment of  far  greater  resources  than  any  practicable 
system  of  taxation  will  afford.  Recourse  must  therefore 
be  had  to  loans.  Government  loans  thus  arising  cannot 
quickly  be  paid  off.  Often  loans  are  negotiated  for  ten, 
twenty,  or  thirty  years ;  and  even  at  the  expiration  of  the 


OTHER   FINANCIAL   INSTITUTIONS 


305 


period  for  which  they  are  contracted,  they  are  frequently 
paid  out  of  the  proceeds  of  new  loans.  The  greater  part 
of  the  public  debt  of  the  United  States  dates  from  the  Civil 
War  ;  a  large  part  of  the  debt  of  Great  Britain  had  its 
origin  in  the  Napoleonic  wars. 

Again,  governments  may  borrow  money  for  the  purpose 
of  carrying  out  a  policy  of  permanent  improvements.  The 
United  States,  for  example,  raises  the  funds  for  the  con- 
struction of  the  Isthmian  Canal  through  loans.  The 
Prussian,  Russian,  Indian,  and  Australian  governments 
have  borrowed  vast  sums  for  the  purpose  of  purchasing 
and  constructing  railways.  Cities  are  continually  borrow- 
ing money  for  similar  purposes.  Especially  where  the 
policy  of  municipal  ownership  finds  favor,  the  demand  for 
capital  for  public  use  is  enormous. 

3.  The  principal  sources  of  supply  of  capital  for  long 
term  investnients  are:  {\)  private  fortunes  accumulated  in 
business,  zvhose  possessors  desire  freedom  from  the  labors 
of  active  management ;  (2)  the  funds  of  endozved  institu- 
tions; (3)  the  funds  accum?tlated  from  private  incomes  and 
kept  as  a  reserve  against  co7itingcncies. 

Just  as  there  are  always  men  who  are  entering  business 
life,  so  there  are  always  men  who  are  retiring  from  active 
business  affairs.  Men  of  the  latter  class  desire  to  obtain 
an  income  from  their  accumulations  without  the  labor  that 
personal  management  entails.  Universities,  hospitals,  and 
other  institutions  receive  money  endowments,  which  must 
be  invested  in  such  a  way  as  to  yield  a  steady  income. 
Wage-earners  and  professional  men  are  under  the  necessity 
of  putting  by  a  part  of  their  incomes  as  a  reserve  against 
sickness  and  old  age,  or  as  a  provision  for  their  dependents 
in  case  of  death.  Capitalists  who  look  forward  to  increasing 
burdens  save  some  part  of  their  interest  receipts ;  active 
business  men  save  part  of  their  profits.  Of  these  savings 
some  part  is  reinvested  in  their  own  business  by  the  men 


3o6  INTRODUCTION   TO   ECONOMICS 

who  save.  A  great  part  of  the  total  fund  of  savings  must, 
however,  be  placed  under  the  control  of  other  persons,  if 
it  is  to  yield  a  considerable  income. 

We  have  now  a  view  of  the  work  that  the  financial  mechan- 
ism must  perform.  It  must  gather  together  the  funds  of 
free  capital  and  place  them  under  the  control  of  those  who 
can  make  best  use  of  such  funds.  We  may  next  proceed 
to  a  study  of  the  methods  by  which  this  work  of  placing 
capital  is  performed. 

4.  The  typical  instruments  employed  in  the  effecting  of 
long  term  and  permanent  investments  are  mortgage  notes, 
bonds,  and  stocks. 

Thetransfer  of  capital  for  long  terms  implies  the  creation 
of  various  instruments  which  serve  as  evidence  of  the  claims 
of  the  capitalist.  The  simplest  type  of  such  instruments 
is  the  promissory  note  secured  by  the  pledge  of  property, 
such  as  houses  and  lands.  Where  the  sum  to  be  raised 
by  a  loan  is  very  great,  as  in  the  case  of  corporation  loans, 
the  resources  of  numerous  lenders  must  be  drawn  upon. 
.  Instead  of  executing  a  great  number  of  separate  notes, 
representing  the  amount  borrowed  from  each  person,  the 
corporation  may  execute  a  note,  secured  by  the  pledge  of 
property,  covering  the  whole  sum,  and  deposit  it  with  a 
trustee.  The  trustee  then  prepares  certificates  represent- 
ing shares  in  the  loan,  and  delivers  them  to  lenders  as 
evidence  of  the  sums  loaned.  Such  certificates  are  known 
as  "bonds."  A  government  may  issue  similar  certificates 
of  indebtedness  without  executing  a  note  representing 
the  entire  loan.  Such  bonds  are  seldom  secured  by  the 
pledge  of  property.  In  any  case  it  is  clear  that  govern- 
ment and  corporation  bonds  are  merely  forms  of  promissory 
notes. 

Instead  of  raising  money  through  an  issue  of  bonds,  a 
corporation  may  sell  shares  of  stock  which  entitle  the 
owner  not  only  to  an  income,  but  to  a  share  in  the  manage- 


OTHER    FINANCIAL    INSTITUTIONS  307 

ment  of  the  enterprise.  In  law  the  position  of  the  stock- 
holder is  very  different  from  that  of  the  bondholder.  The 
former  is  a  partner  in  the  business  undertaking  ;  the  latter 
is  a  creditor  of  it.  In  practical  life  the  ordinary  stock- 
holder has  little  to  do  with  the  control  of  a  corporation. 
He  purchases  stocks  for  the  income  they  yield,  just  as  he 
would  purchase  bonds  for  their  income.  The  bondholder 
is  a  preferred  claimant ;  therefore  bonds,  as  a  rule,  offer 
a  more  certain  income.  The  different  classes  of  bonds  vary 
widely  in  security,  however,  and  many  are  inferior  to  certain 
classes  of  stocks  in  this  respect. 

Such  instruments  —  promissory  notes,  bonds,  and  stocks 
—  are  clearly  not  capital,  but  merely  evidence  of  owner- 
ship of  capital.  We  may,  however,  think  of  the  purchase 
and  sale  of  such  instruments  as  the  purchase  and  sale  of 
capital,  since  the  ownership  of  the.  underlying  productive 
goods  is  transferred  with  the  transfer  of  such  instruments. 
For  convenience  we  may  speak  of  notes,  bonds,  and  stocks 
as  "  investments."  Bonds  and  stocks  are  commonly 
called  "  securities." 

5.   Investments  vary  greatly  in  respect  to  security. 

Investments  of  this  character,  as  has  been  said,  differ 
widely  in  security.  The  long  term  notes  of  business  men 
are  usually  secured  by  the  pledge  of  tangible  property  of 
some  kind,  but  the  property  pledged  may  represent  a  more 
or  a  less  adequate  guaranty  of  repayment.  A  loan  secured 
by  the  pledge  of  land  in  a  semi-arid  region  is  not  so  safe 
as  a  loan  secured  by  the  pledge  of  land  in  a  locality  where 
crop  failures  are  unknown.  A  series  of  dry  years  may 
depopulate  a  semi-arid  district,  and  practically  destroy  the 
value  of  land  there.  Loans  secured  by  suburban  real 
estate  are  not,  as  a  rule,  so  safe  as  loans  secured  by  busi- 
ness property  in  the  heart  of  a  city.  The  bonds  of  a  govern- 
ment like  that  of  the  United  States  are  generally  regarded  as 
safer  investments  than  those  of  Japan  ;  the  bonds  of  the  lat- 


2o8  INTRODUCTION   TO   ECONOMICS 

o 

ter  country  are  safer  than  those  of  Guatemala  or  Venezuela 
Corporation  bonds  similarly  vary  widely  in  security.  Ex^ 
perience  has  shown  that  corporations  frequently  become 
bankrupt,  and  in  such  cases  the  bondholders  may  lose  part  or 
all  of  their  invested  capital.  Stocks,  as  a  rule,  are  yet  more 
uncertain  investments.  When  a  new  interurban  railway  is 
constructed,  no  one  knows  certainly  that  the  business 
which  it  will  carry  on  will  yield  a  fair  return  on  the  capi- 
tal invested ;  if  it  does  not  do  this,  dividends  on  its '  stock 
will  be  low.  Even  in  the  case  of  an  established  business, 
changed  conditions  may  annihilate  profits  and  cause  a 
suspension  of  dividend  payments. 

6.  Investments  vary  in  tJicir  transferability. 

Suppose  that  an  investor  in  New  York  holds  a  note 
secured  by  a  mortgage  on  a  farm  in  one  of  the  western 
states.  In  some  of  the  states  such  a  note  is  not  transfer- 
able at  all.  Even  if  the  laws  are  such  as  to  permit  the  sale 
of  the  note  to  a  third  party,  the  holder  would  find  difficulty 
in  disposing  of  it.  The  buyer  would  need  to  know  some- 
thing of  the  value  of  the  property  pledged  as  security  and 
this  he  might  be  unable  to  ascertain  without  examining  it 
himself.  The  bonds  of  a  small  manufacturing  or  mercan- 
tile corporation  in  one  of  the  minor  cities  would  more  easily 
find  buyers  in  distant  financial  centers.  Even  these,  how- 
ever, would  ordinarily  be  difficult  to  dispose  of.  The  bonds 
of  a  great  railway  or  of  an  industrial  consolidation  always 
find  a  ready  sale.  One  who  invests  in  a  Pennsylvania 
Railway  or  a  United  States  Steel  Corporation  bond  knows 
that' he  can  at  any  time  find  some  one  who  will  be  ready 
to  buy  it  from  him. 

7.  TJie  productiveness  of  an  investvicnt  is  measured  by 
the  ratio  betzveen  its  return  and  its  market  value.  Different 
classes  of  investments  vaiy  ividely  in  productiveness. 

It  is,  perhaps,  straining  the  meaning  of  words  to  speak 
of  a  mortgage  note  or  a  corporation  bond  as  being  "  pro- 


OTHER   FINANCIAL   INSTITUTIONS  30Q 

diictive."  There  is,  however,  reason  to  distinguish  between 
the  securities  that  yield  an  income  and  those  that  yield 
none,  and  the  business  world  has  drafted  the  words  "  pro- 
ductive "  and  "  unproductive  '*'  into  this  service.  We  may 
safely  accept  the  terms,  as  we  are  in  no  danger  of  falling 
into  the  error  of  regarding  notes  and  bonds  as  actually  pro- 
ductive, in  the  physical  sense  of  the  term. 

We  must  distinguish  between  nominal  productiveness 
and  real  productiveness.  A  bond  of  $100  face  value  may 
yield  $4  per  annum.  The  nominal  productiveness  of  capi- 
tal invested  in  such  a  bond  is  four  per  cent.  But  per- 
haps the  bond  may  be  purchased  in  the  market  for  $80. 
In  such  case  the  real  productiveness  of  capital  invested  in 
the  bond  is  five  per  cent.  A  $100  share  of  stock  paying 
dividends  of  ten  per  cent  on  its  par  value  may  sell  at  $200. 
The  real  productiveness  of  capital  invested  in  such  a  stock 
is  no  greater  than  that  of  capital  invested  in  the  four  per 
cent  bond. 

We  need  not  concern  ourselves  here  with  nominal  pro- 
ductiveness. Whether  such  productiveness  is  high  or  low 
is  a  matter  dependent  upon  the  volume  of  securities  cover- 
ing a  specific  earning  power,  and  this  volume  is  arbitrarily 
fixed.  Real  productiveness  varies  widely.  Some  invest- 
ments yield  only  two  per  cent ;  some  yield  ten  per  cent  or 
even  more. 

8.  T/n-  piincipal  cajtse  of  variation  in  the  productiveness 
of  investments  is  risk,  real  or  imagined. 

The  bonds  issued  by  the  United  States  government 
yield  less  than  two  per  cent  on  the  capital  represented  by 
their  market  value.  Bonds  issued  by  the  government  of 
Santo  Domingo,  before  the  time  of  American  intervention 
in  the  affairs  of  that  country,  often  yielded  as  much  as 
twelve  per  cent  on  their  market  value.  Practically  the  only 
reason  for  the  great  difference  in  productiveness  was  the 
difference  in  security.     The  bonds  of  the    several  states 


3IO 


INTRODUCTION   TO   ECONOMICS 


vary  considerably  in  productiveness,  and  the  bonds  of 
municipalities  display  yet  greater  variety.  The  greatest 
variations  in  productiveness  are  to  be  found  in  corporation 
stocks,  for  here  tisk  is  greater  than  in  the  case  of  most 
classes  of  bonds. 

Although  there  may  be  no  real  difference  in  risk  between 
two  investments,  if  it  is  commonly  believed  that  there  is 
such  a  difference,  this  belief  is  reflected  in  the  productive- 
ness of  the  respective  investments.  The  bonds  of  Japan 
may  be  as  safe  as  those  of  the  United  States  ;  but  this  is 
not  generally  believed  to  be  true.  For  this  reason  invest- 
ments in  Japanese  bonds  are  more  than  twice  as  productive 
as  investments  in  United  States  bonds. 

9.  The  productiveness  of  investments  varies  with  their  de- 
gree of  transferability. 

As  a  rule,  the  greater  the  transferability  of  a  form  of 
investment,  the  lower  will  be  its  productiveness.  Few  in- 
vestors are  absolutely  certain  that  they  will  not  at  some 
time  desire  to  regain  control  of  their  funds.  They  will 
therefore  take  at  par  a  bond  that  is  easily  disposed  of 
rather  than  one  of  equal  security  and  equal  nominal  pro- 
ductiveness which  they  might  find  difficulty  in  selling. 
Consequently,  the  price  of  bonds  of  the  former  class  will 
generally  be  higher  than  that  of  bonds  of  the  latter  class, 
A  hundred  dollars  invested  in  the  former  class  of  bonds 
will  yield  a  lower  rate  of  interest  than  a  hundred  dollars 
invested  in  the  latter  class. 

The  bonds  of  a  great  industrial  corporation  are  usually 
less  productive  than  those  of  a  small  one,  on  account  of  the 
greater  transferability  of  the  securities  of  a  well-known 
business  concern.  Most  classes  of  bonds  furnish  less  pro- 
ductive investments  than  small  real  estate  mortgages,  be- 
cause the  latter  can  with  difficulty  be  transferred. 

10.  The  placijtg  of  capital  tnay  be  effected  by  direct  an'ange- 
ments  betzveen  the  capitalist  and  the  enterpriser  or  through 
the  intermediation  of  a  broker  or  other  middleman. 


OTHER   FINANCIAL   INSTITUTIONS  311 

Where  economic  conditions  are  simple,  as  in  an  agricul- 
tural district  or  in  a  small  town,  the  placing  of  capital  may- 
be effected  through  direct  arrangements  between  those  who 
need  capital  and  those  who  have  it  to  spare.  The  moral 
character  and  business  capacity  of  an  enterpriser  is  easily 
ascertained  by  those  who  wish  to  place  their  capital.  A 
man  who  wishes  to  borrow  capital  can  easily  establish  re- 
lations with  those  who  have  capital  to  lend.  Even  in  such 
simple  conditions,  however,  the  individual  borrower  or 
lender  is  often  at  a  disadvantage.  The  former  may  fail  to 
meet  the  men  who  are  ready  to  lend  at  the  lowest  interest 
rate  ;  the  latter  may  fail  to  find  the  safest  and  most  pro- 
ductive investments  for  his  capital.  Hence  the  need  for  a 
middleman,  to  bring  together  borrower  and  lender,  enter- 
priser and  capitalist.  As  industrial  conditions  become  more 
complex,  the  need  for  the  middleman  becomes  more  in- 
tense. It  would  be  quite  impossible  for  the  small  capitalist 
of  a  city  like  New  York  or  London,  to  search  out  the  most 
productive  investments  afforded  by  the  business  of  such 
a  city,  were  there  no  men  who  made  it  their  business  to 
bring  capitalist  and  enterpriser  together. 
.  The  men  who  perform  this  function  may  employ  either 
of  two  methods.  They  may  act  as  mere  agents,  in  behalf 
of  lender  or  of  borrower  or  of  both.  Thus  in  some  towns 
there  are  men  who  undertake,  for  a  fee  or  "  commission," 
to  place  any  man  who  wishes  to  borrow  in  relations  with 
men  who  have  capital  to  lend.  The  function  may,  how- 
ever, be  performed  in  another  way.  Men  with  some  capi- 
tal of  their  own  may  hold  themselves  in  readiness  to 
borrow  any  capital  that  is  offered  for  a  definite  period  of 
time,  trusting  to  the  chance  that  they  will  be  able  to  lend 
it  again  on  more  advantageous  terms.  The  difference  be- 
tween the  interest  received  and  the  interest  paid  represents 
the  profits  of  the  middleman.  This,  we  have  seen,  is  the 
method  employed  by  the  bank  in  its  proper  field. 


312  INTRODUCTION  TO   ECONOMICS 

The  distinction  which  we  have  drawn  between  the  two 
methods  of  placing,  or  marketing,  capital,  finds  its  ana- 
logue, we  readily  see,  in  a  similar  distinction  in  the  methods 
of  marketing  commodities.  A  manufacturer  may  employ 
an  agent,  at  a  fixed  commission,  to  bring  his  wares  before 
the  consuming  public,  or  he  may  sell  them  to  a  merchant, 
who  undertakes  the  responsibility  of  disposing  of  them  to 
consumers, 

11.  /;/  the  great  modern  commercial  ceitters  the  placing  of 
capital  is  effected  largely  through  the  stock  exchanges  —  mar- 
kets for  the  purchase  and  sale  of  securities. 

Under  modern  conditions  an  enormous  amount  of  capi- 
tal is  represented  by  the  bonds  of  nations,  states,  and  mu- 
nicipalities and  of  private  corporations,  as  well  as  by  the 
stocks  of  corporations.  A  government  may  issue  several 
hundred  millions  in  bonds,  all  yielding  the  same  return 
and  having  the  same  security,  and  private  corporation 
issues  of  bonds  and  stQcks  are  sometimes  of  equal  magni- 
tude. A  person  wishing  to  invest  in  a  particular  issue  of 
government  or  corporation  securities  leaves  an  order  with 
a  broker  to  purchase  such  securities  for  him.  A  person 
wishing  to  regain  control  of  capital  invested  in  securities 
leaves  them  with  a  broker  with  orders  to  sell  them.  Natu- 
rally, the  brokers  dealing  in  stocks  and  bonds  establish  the 
custom  of  meeting  at  a  fixed  place,  where  those  who  have 
orders  to  buy  may  meet  those  who  have  orders  to  sell. 
Such  a  meeting-place,  or  market,  is  known  as  a  stock 
exchange.  For  convenience,  each  exchange  makes  rules 
which  brokers  doing  business  there  must  observe.  In  their 
details  these  rules  do  not  concern  us  here ;  in  principle 
they  are  designed  to  insure  effectiveness  and  fair  dealing. 

12.  Since  securities  dealt  in  07i  the  excJmnges  fluctuate  in 
value,  profits  may  be  secured  through  buyijig  wJien  such  se- 
curities are  cheap  and  selling  them  ivhen  dear.  Business  of 
this  nature  is  termed  speculation. 


OTHER    FINANCIAL    INSTITUTIONS  313 

Practically  all  the  securities  dealt  in  on  the  exchanges 
are  constantly  fluctuating  in  price.  The  bonds  of  a  country 
like  the  United  States  are. unusually  stable  in  value,  yet  a 
hundred-dollar  bond  is  somewhat  cheaper  at  one  time  than 
at  another.  If  the  United  States  should  become  involved  in 
a  war,  the  price  of  its  bonds  would  decline,  because  of  the 
probability  of  new  issues.  Even  the  rumor  of  a  war,  how- 
ever slight  its  foundation,  may  affect  adversely  the  price  of 
a  nation's  bonds.  The  bonds  of  a  city  may  decline  in  value 
if  the  city  government  announces  its  intention  of  undertak- 
ing improvements  on  a  large  scale.  The  price  of  bonds  of 
railway  and  industrial  corporations  is  affected  by  every 
change  in  business  conditions.  Price  fluctuation  is  still  more 
common  in  the  case  of  stocks.  It  is  not  unusual  for  the  price 
of  a  given  stock  to  decline  from  ^150  per  share  to  $60  per 
share  within  a  single  year.  Suppose  that  a  company  has 
been  formed  to  exploit  gold  mines  in  Alaska.  Its  shares 
are  offered  on  the  market ;  we  have  read  glowing  accounts 
of  the  prospects  of  the  company,  but  whether  these  ac- 
counts are  reliable  or  not  we  cannot  say.  The  company 
may  earn  enough  to  pay  enormous  dividends;  it  may  earn 
nothing.  What  is  more  natural  than  that  opinion  as  to 
the  value  of  the  stock  should  undergo  frequent  changes, 
and  that  the  price  of  the  stock  should  fluctuate  accordingly.'' 

In  view  of  the  constant  fluctuation  in  securities,  it  is 
natural  that  some  men  should  make  it  their  business  to 
buy  stocks  when  they  appear  to  be  cheap,  with  the  purpose 
of  selling  them  when  prices  rise.  This  is  one  of  the  numer- 
ous forms  of  speculation.  The  buyers  of  stocks  and  bonds  ■ 
are  commonly  divided  into  two  classes — investors  and  specu- 
lators. The  former  class  buy  chiefly  with  the  purpose  of 
enjoying  a  permanent  income  from  the  securities  purchased ; 
the  latter,  chiefly  with  the  hope  of  profiting  from  a  rise  in 
price  of  the  securities. 

13.     Tlie  speculator  provides  enterprises  which  have   710) 


3^4 


INTRODUCTION   TO    ECONOMICS 


yet  demonstrated  their  pozver  to  yield  an  income  with  the 
capital  necessary  for  carrying  on  business. 

Naturally,  the  speculative  buyer  deals  commonly  in  the 
securities  that  show  great  fluctuations  in  price,  while  the 
investor  prefers  the  securities  that  have  a  comparatively 
steady  price.  Now,  it  is  the  securities  of  new  companies 
that  are  most  likely  to  fluctuate  in  value.  After  a  com- 
pany has  been  in  operation  for  a  number  of  years,  its  nor- 
mal earning  power  becomes  established,  and  the  real  value 
of  its  securities  becomes  fairly  well  settled.  Thus  there 
is  a  constant  progress  of  securities  from  the  speculative  class 
to  the  investment  class. 

We  can  now  see  what  one  of  the  economic  functions  of 
stock  speculation  must  be.  So  long  as  the  success  of  a 
company  is  in  doubt,  the  cautious  investor  will  have  noth- 
ing to  do  with  it.  Men  who  are  wilUng  to  take  risks 
—  speculators  —  buy  the  securities  of  such  a  company,  with 
the  expectation  of  selling  them  later  at  a  profit.  In  so  do- 
ing they  furnish  the  company  with  the  funds  necessary  for 
carrying  on  business  operations.  If  the  company  succeeds, 
and  demonstrates  its  power  to  produce  a  large  and  steady 
income,  its  securities  acquire  a  stability  of  value  fitting 
them  for  purposes  of  permanent  investment.  The  specu- 
lators, in  such  cases,  gain  large  profits.  If  the  company 
is  a  failure,  the  speculator  bears  the  loss. 

It  is  of  course  true  that  stock  speculation  offers  great 
opportunities  for  sharp  practice.  A  group  of  speculators 
holding  the  stock  of  a  gold-mining  company  may  succeed 
in  placing  in  circulation  deceptive  accounts  of  the  prospects 
of  the  company,  and  so  manage  to  dispose  of  their  holdings 
to  the  unwary  at  unreasonably  high  prices.  A  group  of 
speculators,  desiring  to  purchase  certain  stocks  at  a  low 
price,  may  circulate  rumors  of  impending  disaster,  and  so 
create  a  panic  among  holders  of  stocks.  Nevertheless,  it  is 
to  be  borne  in  mind  that  the  speculative  buyer  of  stocks  per- 


OTHER    FINANCIAL    INSTITUTIONS  315 

forms  a  very  important  economic  function  in  furnishing 
capital  for  enterprises  tlic  success  of  which  is  still  in  doubt, 
but  which  may  eventually  prove  to  be  highly  profitable. 
The  speculator  stands  in  the  position  of  a  middleman  be- 
tween the  company  which  needs  capital  and  the  cautious 
investor. 

14.  IV/ieu  a  company  seeks  to  raise  capital  tJirougJi  an 
issue  of  securities,  it  may  place  orders  zvitJi  brokers  to 
sell  the  securities  for  what  they  %vill  feteJi,  or  it  may  make, 
with  an  association  of  ivealthy persons,  an  agreement  accord- 
ing to  the  terms  of  which  the  association  assumes  responsi- 
bility for  the  sale  of  the  securities  at  a  definite  price.  Such 
an  association  is  called  an  underwriting  syndicate. 

Let  us  suppose  that  a  great  railway  desires  to  raise  about 
$50,000,000  by  a  new  issue  of  four  per  cent  bonds.  It 
may  place  orders  with  brokers  to  sell  the  bonds  at  what- 
ever price  they  will  command.  The  bonds  of  the  railway 
which  are  already  outstanding  may  be  selling  above  par, 
but  no  one  can  say  exactly  what  effect  on  the  price  of 
bonds  the  new  issue  will  have.  Possibly  the  bonds  will  be 
taken  by  investors  at  par;  possibly  the  price  will  fall  to 
$85  per  hundred  dollar  bond.  Moreover,  it  may  take  a 
long  time  before  all  the  bonds  are  taken  by  speculators  or 
investors.  The  railway  company,  however,  desires  a 
definite  amount  of  capital  at  a  definite  time,  and  cannot 
afford  to  experiment.  So  its  agents  may  make  an  arrange- 
ment with  a  group  of  financiers  whereby  the  latter  agree 
to  insure  the  sale  of  the  entire  issue  at  $95  per  hundred 
dollar  bond.  The  bonds  are  then  placed  on  sale  at,  say, 
i^ioo.  If  the  investing  public  takes  the  bonds  at  this 
price,  the  group  of  financiers,  or  "  underwriting  syndicate," 
gains  a  profit  equal  to  the  difference  between  the  price  to 
the  public  and  the  price  agreed  upon  between  the  railway 
company  and  the  syndicate.  If  the  public  refuses  to  buy, 
the  syndicate  is  compelled  to  take  the  issue  of  bonds  at 


3i6  INTRODUCTION   TO   ECONOMICS 

the  price  agreed  upon — $95.  Possibly  the  syndicate  will 
be  able  to  dispose  of  the  bonds  later  on  favorable  terms, 
possibly  it  will  in  the  end  be  compelled  to  sell  them  at  less 
than  the  price  it  has  paid. 

Where  the  securities  underwritten  by  a  syndicate  are 
of  a  more  speculative  character,  as  for  example  the  stocks 
of  a  new  industrial  corporation,  the  difference  between  the 
price  placed  upon  securities  offered  to  the  public  and  the 
price  to  the  syndicate  is  much  greater.  The  possible  profits 
of  the  syndicate  are  much  greater ;  but  so  also  are  the  poS' 
sible  losses. 

15.  An  investment  company  is  a  company  which  purchases 
and  holds  stocks,  bonds,  mortgages,  etc.,  the  income  of  which 
is  distributed  as  dividends  among  its  oivn  shareholders. 

A  company  may  be  formed  for  the  sole  purpose  of  deal- 
ing in  the  securities  of  other  companies.  Such  a  company — 
which  we  may  call  an  investment  company  —  places  its  stock 
upon  the  market,  and  invests  the  proceeds  of  the  sales  of  such 
stock  in  the  stocks  and  bonds  of  banking,  railway,  franchise, 
and  industrial  corporations,  in  government  bonds,  or  in  real 
estate  mortgages.  The  interest  and  dividends  from  such 
investments  make  up  the  gross  profits  of  the  investment  com- 
pany. From  these  profits  are  deducted  the  expenses  of  ad- 
ministering the  company  ;  the  remainder  may  be  distributed 
among  its  stockholders  as  dividends.  The  advantages  of 
such  a  company  are  obvious.  It  can  employ  men  who  are 
thoroughly  familiar  with  the  securities  market  to  purchase 
stocks  and  bonds  when  the  condition  of  the  market  is 
favorable.  Since  it  purchases  on  a  larger  scale  than  the 
ordinary  investor,  it  may  participate  in  underwriting  syndi- 
cates, and  so  obtain  securities  at  a  lower  price  than  the 
outside  investor  must  pay.  It  may  distribute  its  invest- 
ments so  that  when  some  of  them  fail  to  yield  the  expected 
returns,  others  may  yield  unusually  large  returns.  Thus 
the  stockholders  of   the  investment  company   are    made 


OTHER    FINANCIAL   INSTITUTIONS  317 

more  certain  of  a  steady  income  than  they  would  be  if  they 
invested  their  funds  directly. 

Further,  the  investment  company  may  deal  in  securities 
of  undoubted  value,  which  are  nevertheless  not  well  enough 
known  to  be  easily  transferred.  There  is  no  reason  why  the 
investment  company  should  ever  part  with  such  securities. 
It  may  purchase  mortgage  notes  which  never  would  find  a 
purchaser  on  the  general  market.  As  we  have  seen,  the 
non-transferable  investments  yield,  as  a  rule,  higher  returns 
than  those  that  are  easily  transferred.  Accordingly,  the 
man  who  invests  his  funds  through  an  investment  company 
enjoys  the  higher  income  that  non-transferable  investments 
yield ;  at  the  same  time,  he  can  at  any  time  regain  control 
of  his  funds  through  the  sale  of  his  stock  in  the  investment 
company. 

From  an  economic  point  of  view,  the  investment  com- 
pany is  a  device  which  serves  to  direct  capital  to  the  more 
productive  channels.  In  present-day  business  it  has  largely 
been  diverted  to  another  purpose,  —  that  of  stifling  competi- 
tion. Let  us  suppose  that  in  a  given  territory  two  railways 
are  actively  competing  for  business.  Neither  can  charge 
as  high  rates  as  it  could  if  it  enjoyed  a  monopoly.  Now, 
let  us  suppose  that  an  investment  company  buys  up  a  major- 
ity of  the  stock  of  both  railways.  It  can  then  appoint  the 
directors  of  both  railways,  and  require  them  to  adopt  poli- 
cies which  enable  each  to  fix  high  charges  for  service.  In 
this  way  the  earnings  of  the  railway  companies,  and  hence 
of  the  investment  company,  are  increased.  Hostile  federal 
legislation,  it  is  true,  has  limited  the  efficacy  of  the  invest- 
ment company  as  a  means  for  destroying  competition  be- 
tween railways  ;  but  the  same  device  is  widely  employed  in 
the  case  of  manufacturing  corporations. 

16.  The  savings  bank  performs  the  same  function  for  tJic 
small  investor  that  the  investment  company  performs  for  the 
large  one. 


3i8  INTRODUCTION   TO    ECONOMICS 

It  is  only  persons  possessing  at  least  a  moderate  amount 
of  free  capital  who  can  purchase  with  advantage  investment 
company  shares.  Persons  who  have  no  other  resource  than 
their  daily  labor  need  to  save  some  part  of  their  income 
against  sickness,  old  age,  or  unemployment;  and  these  sav- 
ings should  be  placed  where  they  may  at  once  begin  to  earn 
interest.  The  artisan  who  saves  $$  a  month  cannot  be 
expected  to  keep  the  money  on  his  premises  until  he  has 
accumulated  enough  to  buy  a  share  of  stock.  This  would 
involve  keeping  part  of  his  savings  idle  for  perhaps  twenty 
months.  It  would,  moreover,  expose  such  savings  to  the  re- 
current temptation  to  spend.  Hence  the  need  of  an  institu- 
tion which  will  accept  savings  deposits,  however  small,  pay- 
ing interest  on  them  from  the  beginning,  and  which  will 
return  them  to  the  depositor  upon  reasonable  notice.  Such 
an  institution  is  the  savings  bank. 

Unlike  the  commercial  bank,  described  in  the  last  chap- 
ter, the  savings  bank  can  depend  upon  a  certain  perma- 
nence of  deposits.  Men  who  intrust  their  funds  to  such  an 
institution  do  so,  as  a  rule,  with  the  expectation  of  leaving 
them  for  an  indeiinite  time,  to  earn  interest.  The  rules 
under  which  a  savings  bank  operates  may  of  themselves 
insure  a  reasonable  degree  of  permanence  of  deposits.  De- 
positors are  often  required  to  give  some  days'  or  weeks' 
notice  of  intention  to  withdraw  deposits.  Furthermore, 
interest  is  usually  allowed  only  at  the  end  of  six  months' 
periods ;  withdrawal  at  any  time  within  such  periods  involves 
the  forfeiture  of  accrued  interest. 

Some  part  of  the  deposits  of  a  savings  bank  must  be 
kept  as  a  cash  reserve,  to  meet  possible  withdrawals,  but 
this  reserve  need  not  be  large.  The  remainder  of  the  de- 
posits may  be  invested.  State  laws  generally  specify  the 
classes  of  investments  that  a  savings  bank  may  make,  with 
a  view  to  insuring  the  depositor  against  loss  through  inse- 
cure investments.     Real  estate  mortgages,  federal,  state, 


OTHER    FINANCIAL    INSTITUTIONS  319 

and  municipal  bonds,  are  the  favorite  investments  of  such 
institutions.  The  real  estate  mortgages  present  the  advan- 
tages of  security  and  a  high  degree  of  productiveness; 
government  bonds,  while  yielding  low  returns,  are  easily 
convertible  into  cash  whenever  an  unusual  volume  of  with- 
drawals renders  this  necessary. 

Savings  banks  may  be  organized  as  mutual  associations, 
in  which  case  all  the  profits  from  investments  are  distrib- 
uted among  the  depositors  as  interest.  They  may  be  organ- 
ized as  joint  stock  associations;  in  such  case  the  excess  of 
earnings  above  stipulated  interest  to  depositors  is  distrib- 
uted among  the  stockholders  as  dividends.  The  latter  form 
of  organization  prevails  in  the  West,  the  former  in  the  East. 
In  many  foreign  countries  the  place  of  the  mutual  savings 
bank  is  taken  by  municipal  and  postal  savings  banks.  In 
general,  it  is  recognized  that  the  proper  function  of  the 
savings  bank  is  to  promote  thrift  among  the  poorer  classes, 
not  to  afford  an  opportunity  for  profit  to  the  well-to-do. 
Hence  the  small  depositor  is  frequently  given  the  prefer- 
ence over  the  large  depositor,  receiving  a  higher  rate  of 
interest.  In  many  cases  the  size  of  the  individual  deposit 
is  narrowly  limited. 

17.  The  building  and  loan  associatioji  is  a  form  of  invest- 
ment company  ivhich  limits  its  field  to  small  loans  on  real 
estate  security. 

A  financial  institution  which  in  some  parts  of  the  coun- 
try takes  the  place  of  the  savings  bank  in  promoting  saving 
among  the  working  classes  is  the  building  and  loan  associa- 
tion. Each  member  of  the  association  purchases  a  certain 
number  of  shares  of  "stock,"  paying  for  them  in  monthly 
installments.  If  at  any  time  he  wishes  to  withdraw,  the 
association  returns  to  him  the  sums  which  he  has  paid  in, 
with  or  without  interest,  according  to  the  time  that  has 
elapsed  since  his  first  payment.  If  a  member  desires  to 
build  a  house,  he  may  borrow  from  the  association  a  sum 


320  INTRODUCTION   TO   ECONOMICS 

not  exceeding  the  par  value  of  the  stock  in  the  association 
which  he  holds.  As  security  for  the  loan,  he  gives  a  mort- 
gage upon  the  house  which  he  builds  with  the  aid  of  the 
loan.  He  further  binds  himself  to  make  monthly  payments 
to  the  association  which  represent  interest  on  the  loan, 
plus  some  part  of  the  principal.  Without  entering  upon 
the  details  of  the  organization  of  such  an  association,  we 
can  see  that  its  purpose  is  to  collect  sums  of  capital  from 
persons  of  small  means,  with  the  purpose  .of  loaning  them 
to  other  persons  of  small  means  who  desire  to  own  homes. 
The  latter  class  pay  the  interest  that  the  former  class 
receive. 

18.  From  tJie  financial  point  of  view,  the  life  insurance 
co7npauy  is  a  77iodificd  form  of  itivestment  company.  The 
returns  from  investments  are  for  the  most  part  made  over  to 
the  policy  holders. 

One  further  institution  requires  notice  here :  the  life 
insurance  company.  From  a  financial  point  of  view,  the 
life  insurance  company  is  a  device  for  accumulating  sav- 
ings which  shall  be  returned,  not  to  the  man  who  saves, 
but  to  his  heirs  at  his  demise.  Some  of  the  insured,  it  is 
true,  die  long  before  the  sum  of  the  premiums  they  have 
paid  equals  the  sum  that  the  insurance  company  has 
agreed  to  pay  at  their  death.  On  the  average,  however, 
the  insured  live  long  enough  so  that  their  premiums,  to- 
gether with  the  earnings  of  the  capital  which  those  pre- 
miums form,  are  at  least  equal  to  the  sums  which  the 
insurance  company  pays  out  in  death  claims. 

It  is  obvious  that  in  a  country  like  the  United  States, 
where  life  insurance  is  exceedingly  common,  immense  sums 
of  money  must  be  collected  by  the  companies  every  year, 
to  be  held  as  a  reserve  against  death  claims.  As  the  busi- 
ness of  life  insurance  is  steadily  growing,  the  funds  accu- 
mulated by  these  companies  are  also  increasing.  The 
annual  receipts  of  practically  every  important  life  insur- 


OTHER   FINANCIAL   INSTITUTIONS  321 

ance  company  exceed  the  annual  disbursements.  Accord- 
ingly, a  life  insurance  company  may  invest  its  funds 
without  much  regard  to  the  possibility  of  turning  its  invest- 
ments into  cash  at  short  notice.  It  is  important,  however, 
that  the  business  should  be  conducted  in  a  conservative 
manner,  since  the  failure  of  an  insurance  company  would 
be  a  more  widely  felt  calamity  than  the  failure  of  almost 
any  other  business  enterprise  of  equal  magnitude.  The 
loss  would  be  borne  in  the  end  largely  by  the  dependents 
of  propertyless  men. 

The  reserves  of  life  insurance  companies  are  largely 
invested  in  real  estate  mortgages,  in  state  and  municipal 
bonds,  and  in  the  bonds  of  railway,  commercial,  and  in- 
dustrial corporations.  Stock  investments  have  often  been 
made  by  insurance  companies,  but  the  practice  is  now 
generally  regarded  with  disfavor,  since  the  values  of  stocks 
are  likely  to  show  a  wide  range  of  fluctuation. 

19.  The  mecJianisnt  for  bringing  investor  mid  enterpriser 
togetJier  necessarily  becomes  more  complex  as  industrial 
operations  increase  in  magnitude. 

In  a  small  village,  the  investor  and  the  enterpriser  enter  in- 
to direct  relations  with  each  other.  In  a  larger  town,  funds 
flow  from  the  investor  to  the  enterpriser  through  the  inter- 
mediation of  a  broker.  In  a  great  city  funds  flow  from 
the  investor  to  the  enterpriser  through  the  intermediation 
of  a  series  of  brokers  and  a  series  of  speculators ;  often 
other  functionaries,  such  as  the  underwriter  and  the  in- 
vestment company,  insert  themselves  in  the  chain  connect- 
ing the  two  primary  financial  classes  —  the  investor  and 
the  enterpriser.  We  shall  understand  this  flow  of  funds 
better  if  we  construct  a  diagram  representing  it  in  all  its 
complexity :  — 


322  INTRODUCTION   TO   ECONOMICS 

Stockholder        Depositor      Policy  Holder 

V  I  I 

Independent  Investor      Investment  Co.      Savings  Bank      Insurance  Co. 

V 
(Broker) 

Speculator 

(Broker) 

Underwriting  Syndicate 

Industrial  Enterprise 

In  our  diagram  the  broker  is  placed  in  parenthesis,  be- 
cause he  is  nominally  an  agent  for  the  investor  or  the 
speculator.  The  diagram  is  less  complex  than  the  reality, 
because  it  assumes  that  only  one  speculator  figures  in  the 
chain,  when  in  fact  a  security  may  pass  from  one  specu- 
lator to  another  for  years  before  its  value  becomes  suffi- 
ciently stable  to  attract  the  interest  of  investors. 

20.    Snnimary. 

In  modern  economic  society  there  is  a  constant  flow  of 
funds  from  the  capitalist  class  to  the  enterpriser  class. 
The  purchase  or  improvement  of  real  estate,  the  financing 
of  large  business  enterprises,  and  the  extraordinary  needs 
of  governments  give  rise  to  the  demand  for  long  term  in- 
vestment ;  men  retiring  from  active  business  life,  endowed 
institutions,  and  persons  accumulating  capital  against 
future  needs  furnish  the  supply  of  such  funds.  This  flow 
of  capital  may  be  represented  as  the  purchase  and  sale 
of  stocks,  bonds,  and  mortgage  notes. 

Long  term  investments  vary  widely  in  security  and 
transferability.  As  a  rule,  the  greater  the  degree  of  secur- 
ity and  transferability,  the  less  the  productiveness  of  an 
investment. 

The  placing  of  capital  may  be  effected  through  direct 
arrangement  between  the  capitalist   and   the   enterpriser, 


OTHER   FINANCIAL    INSTITUTIONS  323 

or  through  the  intermediation  of  a  broker  or  other  middle- 
man. The  broker  may  carry  on  his  business  independently, 
or  he  may  join  with  other  brokers  in  organizing  a  stock 
exchange.  The  purchasers  of  stocks  and  bonds  may  hold 
them  for  the  income  which  they  yield,  or  for  a  rise  in  price. 
In  the  former  case  the  purchasers  are  classed  as  investors, 
in  the  latter,  as  speculators.  When  an  enterprise  is  new, 
its  securities  are  chiefly  held  by  speculators ;  when  its 
business  is  well  established,  the  securities  are  likely  to  pass 
into  the  hands  of  permanent  investors.  Thus  the  specula- 
tor appears  in  the  light  of  an  intermediary  between  the  en- 
terpriser and  the  ultimate  investor. 

Investment  may  be  made  through  various  institutions, 
instead  of  directly  by  the  capitalist.  The  most  important 
of  these  are  the  investment  company,  the  savings  bank, 
the  building  and  loan  association,  and  the  life  insurance 
company.  These  institutions  are  adapted  to  the  peculiar 
needs  of  different  classes  of  investors.  They  share  in 
common  the  advantages  of  expert  skill  in  the  making  of 
investments  and  of  power  to  distribute  investments  in  such 
a  way  as  to  minimize  risk. 


t) 


CHAPTER    XVIII 

INTERNATIONAL   TRADE   AND   FOREIGN   EXCHANGE 

1.  All  permaiioit  trade  rests  upon  differences  in  produc- 
tive powers. 

From  early  modern  times,  when  men  first  began  to 
think  systematically  upon  economic  subjects,  a  great  deal 
of  attention  has  been  bestowed  upon  the  exchange  of 
goods  between  persons  living  under  different  governments, 
or  international  trade.  It  was  for  a  long  time  believed  (and 
it  is  still  widely  believed)  that  such  trade  differs  radically 
in  its  nature  from  trade  that  is  carried  on  within  the  limits 
of  a  single  country.  While  the  latter,  it  is  generally  ad- 
mitted, is  an  unmixed  good,  and  ought  to  be  encouraged, 
or  at  any  rate  granted  the  most  perfect  freedom  by  govern- 
ment, the  former,  many  believe,  is  often  a  doubtful  blessing 
and  ought  to  be  closely  scrutinized  and  regulated,  and, 
under  many  circumstances,  discouraged  or  even  prohib- 
ited. Whether  there  is  any  justice  in  this  distinction  be- 
tween the  two  branches  of  trade  is  a  question  that  we  must 
defer  to  the  next  chapter.  For  the  present,  we  are  con- 
cerned with  the  conditions  giving  rise  to  international  trade 
and  the  mechanism  by  which  it  is  carried  on. 

All  permanent  trade  is  based  upon  differences  in  char- 
acter of  productive  powers.  To  employ  a  simple  example, 
drawn  from  the  field  of  local  trade,  if  A  can  make  three 
pairs  of  shoes  in  a  day  while  B  can  make  only  two,  and  B 
can  cut  two  cords  of  wood  in  a  day  while  A  can  cut  only 
one,  the  basis  for  permanent  trade  between  them  exists. 
It  will  pay  A  to  get  all  his  wood  from  B,  exchanging  shoes 
for  it.  The  assumed  difference  in  character  of  productive 
powers  may  have  originated  in  differences  in  natural  apti- 
tudes or  in  differences  in   training.     In  either  case   the 

324 


INTERNATIONAL  TRADE  AND  FOREIGN  EXCHANGE  325 

difference  in  productive  powers  is  the  essential  basis  of  a 
continuous  interchange  of  commodities. 

But  suppose  that  A  can  not  only  make  more  shoes  in  a 
day  than  B  can  make,  but  can  also  cut  more  wood.  Does 
this  supposition  preclude  the  possibility  of  a  permanent  in- 
terchange of  products  between  A  and  B  .■'  Not  at  all. 
Suppose  that  A  can  make  three  pairs  of  shoes  in  a  day  or 
cut  two  cords  of  wood,  while  B  can  make  only  one  pair  of 
shoes,  or  cut  only  one  cord  of  wood.  With  two  days'  work 
B  can  produce  as  much  wood  as  A  can  with  one ;  with  two 
days'  work  he  cannot  produce  as  many  shoes  as  A  can 
with  one.  Accordingly,  it  would  pay  him  to  offer  A  the 
product  of  a  little  more  than  two  days  of  his  own  work  at 
woodcutting,  in  exchange  for  the  product  of  one  day  of 
A's  work  at  making  shoes.  And  it  would  pay  A  to  accept 
the  offer.  B  suffers  under  a  disadvantage  in  either  occu- 
pation, but  his  disadvantage  is  less  in  woodcutting  than  in 
shoemaking.  A  enjoys  an  advantage  in  either  occupation, 
but  his  advantage  is  greater  in  shoemaking  than  in  wood- 
cutting. Common  sense,  then,  urges  B  to  confine  himself 
to  cutting  wood,  A  to  making  shoes. 

In  the  trade  between  inhabitants  of  one  part  of  the 
earth's  surface  with  those  of  another  part,  differences  in 
personal  aptitude  and  training  of  the  kind  assumed  in  the 
foregoing  example  are  supplemented  by  differences  of  a 
more  general  nature.  One  region  may  have  excellent  min- 
eral deposits  but  lack  fertile  land  for  the  growing  of  food  ; 
another  region  may  be  quite  devoid  of  minerals,  but  abun- 
dantly supplied  with  rich  lands.  In  one  region  the  char- 
acter of  the  population  may  be  such  as  to  fit  it  for  kinds  of 
work  requiring  skill  and  taste,  but  not  such  as  to  fit  it  for 
kinds  of  work  requiring  great  muscular  strength  and  endur- 
ance. In  another  region  the  population  may  be  almost  in- 
capable of  acquiring  taste  and  skill,  although  it  is  well 
fitted  for  labor  demanding  rude  muscular  power.     Capital 


326  INTRODUCTION   TO    ECONOMICS 

may  be  plentiful  and  cheap  in  one  region  and  scarce  and 
dear  in  another.  In  this  case  industries  requiring  vast 
capital  can  be  operated  to  greater  advantage  in  the  former 
region  than  in  the  latter.  Land  may  be  plentiful  in  one 
region,  relatively  to  the  population,  and  scarce  in  another. 
Industries  requiring  an  extensive  use  of  land  will  find  their 
natural  habitat  in  the  former  region.  The  populations  of 
two  regions,  though  differing  little  in  fundamental  charac- 
ter, may  differ  widely  in  their  attitude  toward  particular 
forms  of  toil.  They  possess  different  habits,  or,  more 
properly,  traditions  of  workmanship,  which  fit  the  one 
better  for  one  kind  of  labor,  the  other  for  another.  So 
long  as  any  of  these  differences  persist,  there  is  obviously 
reason  why  there  should  be  differences  in  the  industries  of 
the  two  regions.  With  adequate  means  of  communication, 
trade  between  the  two  regions  naturally  arises. 

2.  Economically  considered,  trade  should  be  classified  as 
local  and  interregional,  not  as  domestic  and  international. 
The  latter  classification  may,  however,  be  regarded  as  practi- 
cally equivalent  to  the  former. 

We  have  spoken  of  differences  between  regions,  not 
differences  between  nations.  From  a  purely  economic  point 
of  view,  trade  is  either  local  or  interregional,  not  domestic 
or  international.  The  trade  between  Belgium  and  the 
adjacent  departements  of  France  is  economically  of  the 
same  character  as  the  trade  between  Rhode  Island  and  Mas- 
sachusetts. The  trade  between  California  and  Hawaii  is 
of  the  same  essential  character  as  the  trade  between  New 
York  and  Santo  Domingo.  From  an  economic  point  of 
view  local  trade  is  that  which  originates  in  such  differ- 
ences in  natural  aptitudes  and  industrial  training  as  may  for 
a  long  time  persist  on  the  same  soil.  Differences  in  natural 
endowment,  in  general  character  of  population,  in  rates  of 
wages  and  interest,  characterize  interregional  trade.  As  a 
rule,  however,  international   trade   is    also    interregional; 


INTERNATIONAL  TRADE  AND  FOREIGN  EXCHANGE  327 

hence  the  principles  that  apply  to  the  latter  may  without 
serious  qualification  be  applied  to  the  former.  Since  the 
classification  of  trade  as  domestic  and  international  is  widely 
used,  we  shall  accept  it,  in  spite  of  its  inaccuracy,  in  the 
following  pages. 

3.  Ti'ade  be  five  en  tzvo  regions  or  nations  may  be  based  upon 
ike  fact  that  caeh  one  produees  goods  of  a  kind  that  cannot 
be  produced  xvithin  the  boundaries  of  tJie  other. 

In  some  cases  the  products  of  two  regions  are  quite  dis- 
similar. Neither  region  can  produce  the  commodities 
which  it  receives  from  the  other.  Thus  in  the  Middle  Ages 
an  important  trade  was  carried  on  between  Northern 
Europe  and  the  Indies.  The  former  region  furnished  furs 
and  amber,  the  latter,  spices  and  gems.  A  modern  example 
of  the  same  sort  of  trade  is  the  exchange  of  iron  and  steel 
products  for  teas,  coffee,  and  spices  between  England  on 
the  one  hand,  and  the  East  Indies  on  the  other.  In  general, 
the  trade  between  countries  in  the  temperate  zone,  on  the 
one  hand,  and  countries  in  the  torrid  zone,  on  the  other,  is 
largely  of  this  character.  Trade  having  this  basis  is  nat- 
urally permanent ;  with  every  reduction  in  costs  of  trans- 
portation it  tends  to  increase.  Decline  in  railway  and 
ocean  shipping  charges  places  more  and  cheaper  tropical 
products  in  our  hands,  and  places  more  of  our  products  in 
the  hands  of  the  inhabitants  of  the  tropics.  Furthermore, 
we  are,  as  a  people,  gradually  learning  to  appreciate  the 
good  qualities  in  tropical  products  that  a  short  time  ago 
we  held  in  slight  esteem ;  and  we  may  assume  that  a  cor- 
responding evolution  is  taking  place  in  the  tastes  of  the  in- 
habitants of  the  tropics. 

4.  EaeJi  one  of  two  trading  nations  may  be  able  to  produce 
all  classes  of  commodities  that  are  the  objects  of  exchange  be- 
tween them.  In  this  case,  the  one  is  likely  to  enjoy  greater 
relative  advantages  for  the  production  of  one  class  of  com- 
modifies,  the  other  for  the  production  of  another  class. 


328  INTRODUCTION   TO   ECONOMICS 

More  commonly  one  of  the  trading  regions,  or  both, 
can  produce  both  classes  of  commodities  exchanged.  The 
United  States  can  produce  both  sugar  and  pork ;  so  also 
can  Cuba.  But  the  United  States  possesses  exceptional  ad- 
vantages for  the  production  of  pork ;  for  the  production  of 
sugar  it  is  not  especially  well  adapted.  Cuba,  on  the  other 
hand,  has  unsurpassed  advantages  for  the  production  of 
sugar,  but  can  produce  pork  with  only  a  moderate  degree  of 
success.  It  is,  therefore,  natural  that  an  exchange  of  prod- 
ucts between  the  two  countries  should  take  place.  Were 
there  no  artificial  hindrances  to  such  exchange,  we  should 
adjust  our  production  in  such  a  way  as  to  produce  all 
the  pork  that  Cuba  needs,  and  Cuba  would  devote  more  of 
her  productive  resources  to  the  growing  of  sugar  for  our 
consumption. 

5.  Tj'adc  based  upon  differences  in  productive  power  aris- 
ing from  differences  in  the  character  of  tzvo  populations  is 
permanent  in  character  and  tends  to  increase  ivitJi  improve- 
ments in  trajisportatiou. 

Among  the  conditions  upon  which  international  trade  is 
based,  we  mentioned  differences  in  the  essential  character 
of  the  populations  of  trading  regions.  Such  differences  in 
character  are  difficult  to  define,  since  the  characters  of 
nations,  as  of  individuals,  are  always  thickly  overlaid  with 
custom  and  habit.  Nevertheless,  we  may  be  quite  sure 
that  such  differences  exist.  The  German  is  not  exactly  the 
same  kind  of  man  as  the  Englishman,  even  if  due  allow- 
ance is  made  for  acquired  traits.  Still  less  is  the  Japanese 
the  same  kind  of  man  as  the  American.  It  is  therefore 
safe  to  assume  that  in  some  of  the  manifold  branches  of 
industry  the  German  will  be  superior  to  the  Englishman, 
while  in  some  he  will  be  inferior.  We  may  certainly  as- 
sume that  in  some  branches  of  industry  the  Japanese  will 
be  more  successful  than  the  American,  while  in  other 
branches  he  will  be  less  successful. 


INTERNATIONAL  TRADE  AND  FOREIGN  EXCHANGE  329 

Cotton  can  be  grown  successfully  by  the  native  popula- 
tion of  Central  Africa.  The  tedious  labor  under  a  tropic 
sun  is  more  easily  borne  by  the  native  blacks  than  it  would 
be  by  persons  of  European  descent.  The  manufacture  of 
cotton  cloth  by  modern  methods  requires  a  higher  degree 
of  intelligence,  perseverance,  and  responsibility  than  the 
native  African  population  possesses.  This  branch  of  the 
industry  may  better  be  carried  on  in  a  country  like  Eng- 
land, where  the  population  has  the  required  traits  in  a 
high  degree  of  development.  Accordingly,  there  is  a 
natural  basis  for  permanent  trade  between  England  and 
Central  Africa.  Trade  based  upon  such  essential  differ- 
ences in  national  character  also  tends  to  increase  in  im- 
portance with  improvements  in  the  means  of  transportation 
and  communication. 

6,  International  trade  based  upon  differences  in  relative 
supply  of  land  eventnally  loses  a  large  part  of  its  importance 
on  account  of  tJie  movements  of  population. 

Trade  based  upon  differences  in  relative  supply  of  land 
attained  extraordinary  proportions  during  the  nineteenth 
century.  The  Old  World,  for  the  most  part,  was  densely 
peopled  ;  in  the  New  World  population  was  sparse.  It  is 
a  well-known  fact  that  the  largest  output  per  workman  of 
agricultural  products  is  attained  through  the  superficial  cul- 
tivation of  large  areas.  England  may  have  lands  that  are 
naturally  better  adapted  for  the  growing  of  wheat  than  the 
lands  of  Argentina.  But  it  is  hardly  possible  for  one  man 
cultivating  twenty  acres  in  England  to  produce  as  many 
bushels  of  wheat  as  one  man  cultivating  two  hundred  acres 
in  Argentina. 

In  manufactures,  on  the  other  hand,  density  of  popula- 
tion, instead  of  reducing  productive  efficiency,  tends  to  in- 
crease it.  Men  who  live  in  constant  association  are  better 
fitted  for  the  organized  activity  of  the  modern  factory  than 
are  men  who  pass  their  lives  in  the  isolation  of  the  frontier. 


330  INTRODUCTION  TO    ECONOMICS 

Hence  an  exchange  of  agricultural  products  for  manufac- 
tures between  the  New  World  and  the  Old  was  in  the  nat- 
ural order  of  events. 

During  the  greater  part  of  the  nineteenth  century  trade 
between  the  United  States  and  England  was  chiefly  of  the 
character  just  described.  The  United  States  possessed 
vast  tracts  of  land  for  extensive  cultivation ;  England  had 
a  dense  population  well  fitted  for  factory  labor.  Hence 
we  exported  foodstuffs  and  raw  materials  and  imported 
manufactures. 

While  trade  upon  this  basis  tends  to  increase  with  re- 
duction in  costs  of  transportation,  there  is  a  counter  tend- 
ency at  work  which  in  time  checks  it.  Immigration  flows 
into  the  regions  rich  in  land ;  the  natural  increase  of 
population  in  those  regions  is  likely  to  be  rapid.  In  the 
end  such  regions  lose  their  peculiar  advantages  in  the 
production  of  foodstuffs  and  raw  materials,  and  gain  in 
power  to  produce  manufactures  cheaply.  Trade  of  the 
character  under  discussion  may  continue  for  centuries,  but 
ultimately  it  decays.  The  United  States  still  exports  large 
quantities  of  foodstuffs  and  raw  materials  and  imports 
manufactured  goods.  But  these  elements  in  our  foreign 
trade  no  longer  maintain  their  former  supremacy.  In  an- 
other century  the  United  States  will  doubtless  import 
chiefly  raw  materials  and  foodstuffs  from  regions  which 
remain  sparsely  peopled  and  export  manufactures  in 
exchange. 

7.  International  trade  based  upon  differences  in  relative 
supply  of  capital  is  of  watting  importance,  sijice  capital 
Jioivs  easily  from  country  to  country. 

We  need  not  dwell  at  length  upon  the  trade  that  is 
based  upon  differences  in  the  supply  and  cheapness  of 
capital.  So  long  as  England  was  par  excellence  the  land  of 
capital,  and  so  long  as  English  capitalists  were  unwilling 
to  invest  their  funds  in  foreign  lands,  there  were  many 


INTERNATIONAL  TRADE  AND  FOREIGN  EXCHANGE  331 

branches  of  manufacture  that  could  be  prosecuted  with 
far  greater  advantage  in  England  than  in  other  countries. 
In  practically  every  branch  of  manufacture,  in  fact,  the 
interest  on  capital  makes  up  a  far  larger  proportion  of  the 
total  expenses  than  in  grazing,  agriculture,  lumbering,  etc. 
It  is  easy  to  see,  then,  that  English  manufacturers,  with 
interest  at  five  per  cent,  enjoyed  a  decided  advantage  over 
American  manufacturers,  with  interest  at  eight  per  cent. 
The  English  farmers  and  stockmen,  it  is  true,  also  had  an 
advantage  in  interest  rates  over  their  American  competitors. 
But  the  advantage  was  of  less  relative  importance  and  more 
easily  offset  by  other  factors  in  which  the  Americans  en- 
joyed an  advantage,  such  as  cheaper  land. 

Under  present-day  conditions  no  country  can  long  hold 
a  branch  of  trade  merely  through  cheapness  of  capital. 
Like  labor,  capital  tends  to  migrate  to  the  less  developed 
regions  of  the  world ;  its  migration  involves  far  less  per- 
sonal sacrifice  and  far  less  cost.  Furthermore,  capital  in- 
creases rapidly  in  the  newer  lands.  If  interest  rates  were 
much  higher  in  the  United  States  than  in  Great  Britain, 
British  capital  would  steadily  flow  into  the  former  country  ; 
and  this  influx  of  capital,  added  to  the  new  capital  con- 
stantly accumulating  here,  would  tend  to  depress  interest 
rates,  until  there  remained  no  perceptible  difference  in  the 
rates  prevailing  in  the  two  countries.  The  trade  based 
upon  differences  in  capital  supply  may,  therefore,  be  re- 
garded as  transitory. 

8.  International  trade  based  7tp0Jt  differences  in  traditions 
of  ivorkmanship  often  manifests  a  high  degree  of  perma- 
nence. 

In  a  region  that  has  long  been  devoted  chiefly  to  a  given 
branch  of  industry,  something  that  we  may  call  a  tradition 
of  workmanship  evolves.  The  best  type  of  iron  worker  is 
not  developed  in  a  single  generation.  The  mill  that  is 
manned  with  workers  whose    fathers  and  whose  fathers' 


332  INTRODUCTION   TO   ECONOMICS 

fathers  were  reared  in  a  world  of  iron  manipulation  pos- 
sesses a  decided,  though  indefinable,  advantage  over  the 
mill  that  is  manned  with  workers  whose  antecedents  were 
of  the  field  or  forest.  Costly  experiments  in  settling  urban 
stock  upon  farms  have  demonstrated  the  soundness  of  the 
popular  view  that  it  takes  generations  to  make  a  farmer. 
Still  more  important  is  the  tradition  of  workmanship  in  in- 
dustries requiring  a  high  degree  of  taste  and  skill.  Where 
is  the  Occidental  who  can  produce  a  true  Oriental  rug  ? 

When  other  conditions  are  ripe,  the  population  of  any 
region  may  develop  the  tradition  of  workmanship  neces- 
sary for  the  successful  prosecution  of  any  specific  branch 
of  industry.  But  no  region  can  be  expecteel  to  gain  a  su- 
periority in  all  lines.  We  may  at  some  future  time  be  able 
to  make  gowns  as  well  as  the  French,  and  ivory  toys  as  well 
as  the  Japanese.  But  there  will  always  be  objects  of  taste 
which  we  must  buy  from  the  French  and  the  Japanese. 
Trade  based  upon  such  differences  may,  therefore,  be 
treated  as  permanent  in  character. 

9.  The  foreign  trade  of  uiodeni  nations  is  based  upon  a 
combination  of  differences,  some  of  a  permanent  and  some  of 
a  transitory  nature. 

In  the  foreign  trade  of  a  great  country  like  the  United 
States  or  Great  Britain  it  is  natural  that  we  should  find 
one  part  having  one  underlying  basis,  another  part  another 
basis.  In  many  cases  the  exportation  or  importation  of  a 
commodity  arises  from  a  combination  of  several  of  the 
causes  which  we  have  described  as  bases  of  trade.  The  ex- 
portation of  iron  and  steel  products  from  Great  Britain  to 
India  is  based  upon  the  fact  that  Great  Britain  has  vastly 
superior  deposits  of  iron  ore  and  coal,  cheaper  capital,  and 
a  population  better  fitted  than  that  of  India  for  metallurgi- 
cal industry  and  possessing  a  superior  tradition  of  work- 
manship. The  exportation  of  wheat  from  the  United 
States  to  England  is  based  solely  upon  the  greater  abun- 


INTERNATIONAL  TRADE  AND  FOREIGN  EXCHANGE  ^^^ 

dance  of  land,  relatively  to  the  population,  in  the  former 
country.  The  importation  into  the  United  States  of  French 
articles  of  taste  may  be  due  in  part  to  superiority  of  the 
French  national  character,  in  this  respect;  but  it  is  un- 
doubtedly due  in  large  part  to  a  superior  tradition  of  work- 
manship on  the  part  of  the  French.  With  the  lapse  of 
time  we  shall  cease  to  export  many  of  the  commodities  we 
now  export;  many  of  the  commodities  which  we  now  im- 
port will  be  produced  in  this  country. 

10.  A  country  may  import  commodities  for  the  production 
of  zvhich  it  is  better  fitted  by  nature  tJiaii  are  the  countries 
which  export  these  commodities.  Such  a  proceeding  is 
economical  zuhen  the  first  country  enjoys  evoi  greater  advan- 
tages in  the  production  of  other  commodities  than  the  other 
countries  enjoy. 

We  have,  hitherto,  considered  only  cases  in  which  each 
one  of  two  trading  regions  possesses  unique,  or  at  any  rate 
superior,  advantages  in  the  production  of  the  commodities 
which  it  exports.  Under  certain  conditions  trade  may  be 
advantageous  even  when  this  is  not  the  case.  To  use  a 
time-honored  illustration,  let  us  suppose  that  the  United 
States,  by  reason  of  its  natural  wealth  and  the  character  of 
its  population,  is  in  a  better  position  to  produce  both  wheat 
and  steel  than  England.  A  day's  labor  will  produce  more 
of  either  commodity  in  America  than  in  England.  Yet  it 
may  be  profitable  for  the  United  States  to  buy  its  steel 
from  England,  giving  wheat  in  exchange.  We  will  assume 
that  in  America  a  day's  labor  will  produce  four  bushels  of 
wheat  or  two  hundredweights  of  steel,  while  in  England  a 
day's  labor  will  produce  one  bushel  of  wheat  or  one  hun- 
dredweight of  steel.  Disregarding  the  costs  of  transporta- 
tion, it  would  be  profitable  for  America  to  offer  England 
three  bushels  of  wheat  in  exchange  for  two  hundredweights 
of  steel,  and  it  would  be  profitable  for  I^ngland  to  ac- 
cept the  offer.     America  would  thus  obtain  two  hundred- 


334  INTRODUCTION   TO   ECONOMICS 

weights  of  steel  for  three  fourths  of  a  day  spent  in  wheat 
growing,  instead  of  spending  a  whole  day's  labor  in  making 
the  steel.  England  would  obtain  three  bushels  of  wheat 
through  two  days'  labor  spent  in  steel  making,  instead  of 
spending  three  days'  labor  producing  the  same  amount  of 
wheat.  America  possesses  an  advantage  in  either  industry, 
but  her  advantage  is  greater  in  wheat  growing.  England 
is  at  a  disadvantage  in  either  branch  of  production,  but 
her  disadvantage  is  less  in  steel  making.  It  is  therefore 
natural,  under  the  assumed  conditions,  that  America  should 
make  a  specialty  of  wheat  production,  England  of  steel 
making,  and  that  the  two  countries  should  carry  on  a 
mutually  profitable  trade. 

This  case  is  obviously  analogous  to  the  case  of  ex- 
change between  shoemaker  and  woodcutter  which  we  em- 
ployed in  the  early  part  of  this  chapter.  But  while  any 
person  of  ordinary  intelligence  can  see  how  it  may  be  prof- 
itable for  an  efficient  shoemaker  to  hire  a  man  less  fitted 
than  himself  for  woodcutting  to  supply  him  with  wood,  it 
appears  to  be  beyond  the  comprehension  of  most  ordinary 
men,  and  many  extraordinary  ones,  that  a  country  can  prof- 
itably pursue  the  same  business  policy.  Since  a  day's 
labor  does  actually  produce  more  steel  in  the  United  States 
than  in  England,  many  men  believe  that  it  must  be  unprofit- 
able for  us  to  buy  steel  from  England.  Obviously,  they 
fail  to  consider  the  possibility  that  we  may  have  other  in- 
dustries so  much  more  productive  than  those  of  England  that 
we  cannot  afford  to  divert  our  labor  to  the  making  of  steel. 

11.  From  the  fact  that  a  coiintry  has  greater  natural  ad- 
vantages for  the  production  of  a  commodity  than  other 
countries  enjoy,  it  does  not  necessarily  folloio  that  the  money 
cost  of  the  commodity  is  lozvcr  in  the  former  country  than  in 
the  others. 

Let  us  look  at  the  matter  from  another  point  of  view  — 
that  of  prices  and  money  cost  of  production.     The  men  who 


INTERNATIONAL  TRADE  AND  FOREIGN  EXCHANGE  335 

engage  in  the  business  of  importing  and  exporting  commodi- 
ties do  not  inquire  into  underlying  bases  of  trade.  Their 
inquiries  begin  and  end  with  prices.  Is  steel  cheaper  in 
England  than  in  America  ?  If  so,  and  if  the  difference  is 
great  enough  to  pay  the  cost  of  transportation,  they  import 
the  steel,  unless  they  are  prevented  by  government  from 
doing  so.  Is  wheat  cheaper  in  America  than  in  England.'' 
If  it  is  enough  cheaper  to  pay  the  costs  of  transportation, 
they  export  it. 

But  why  should  steel  be  cheaper  in  England  than  in 
America,  while  wheat  is  cheaper  in  the  latter  country  ? 
Prices,  we  know,  tend  to  equal  money  cost  of  production  ; 
therefore  we  may  assume  that  it  costs  less  to  produce  steel 
in  England,  wheat  in  America.  Our  inquiries  cannot  stop 
here,  however,  for  we  must  know  why  it  costs  more  to  pro- 
duce the  one  commodity  in  the  one  country,  the  other  com- 
modity in  the  other  country. 

Ask  a  steel  manufacturer  why  it  costs  more  to  produce 
steel  in  this  country  than  in  England,  and  he  will  probably 
reply,  "  Labor  is  dearer."  The  pay  of  English  steel  workers 
is,  indeed,  lower  than  that  of  steel  workers  in  America,  but 
so  also  is  the  pay  of  English  agricultural  laborers  lower  than 
that  of  farm  hands  in  America.  It  is,  therefore,  plain  that  it 
is  not  the  low  wages,  absolutely  considered,  that  give  the 
British  steel  manufacturer  an  advantage,  but  the  low  wages, 
relatively  to  the  productive  efficiency  of  the  workmen. 
Low  wages  do  not  make  British  agriculture  prosperous,  be- 
cause the  productive  efificiency  of  laborers  in  that  industry 
is  low,  relatively  to  wages.  The  disadvantage  of  the  British 
steel  industry  as  compared  with  the  American  is  less  than 
the  disadvantage  of  British  agriculture  as  compared  with 
American. 

12.  //  is  profitable  to  import  a  commodity  whenever  labot 
and  capital  engaged  in  its  prodnction  yield  less  than  tJie  same 
agents  would  yield  in  other  fields. 


336  INTRODUCTION   TO   ECONOMICS 

We  shall  get  a  clearer  view  of  the  situation  if  we  stop 
to  consider  the  principles  determining  cost  of  production. 
Wages  and  interest  are  the  chief  constituents  of  cost  of  pro- 
duction ;  but  we  will  fix  our  attention  upon  wages  alone. 
In  earlier  chapters  we  saw  that  wages  are  determined  by 
the  marginal  productivity  of  labor.  Now,  let  us  suppose 
that  one  trading  region  has  a  vast  extent  of  fertile  land  and 
a  sparse  population.  Only  the  best  lands  are  tilled  and 
these  in  a  superficial  way.  Add  a  thousand  laborers  to  the 
population.  How  much  can  they  produce.''  Perhaps  five 
bushels  per  man  a  day.  This  amount  of  wheat,  or  the  price 
of  it,  they  can  demand  as  wages ;  all  other  equally  efificient 
workmen  will  get  as  much,  but  no  more.  Another  trading 
region  has,  let  us  say,  a  dense  population  and  little  land. 
All  the  good  lands  are  carefully  tilled ;  most  of  the  poor 
lands  are  also  under  cultivation.  Add  a  thousand  men  to  the 
working  population.  It  is  highly  improbable  that  these  men 
will  increase  the  product  by  five  bushels  per  man  per  day. 
Rather,  we  may  assume  that  the  daily  product  of  a  man  is 
only  one  bushel.  And  this,  or  its  price,  is  all  that  any 
equally  efficient  laborer  in  the  society  can  get. 

If  the  two  regions  are  in  easy  communication  with  each 
other,  the  price  of  wheat  in  the  one  will  be  the  same  as  the 
price  in  the  other,  allowance  made  for  the  cost  of  shipping 
wheat  from  the  one  to  the  other  —  a  few  cents  per  bushel,  we 
will  assume.  This  means  that  money  wages  will  be  much 
higher  in  the  region  which  is  sparsely  settled  than  in  the 
region  where  population  is  dense. 

Now,  let  us  suppose  that  each  region  possesses  ores  and 
coal,  but  that  the  deposits  of  the  sparsely  settled  region  are 
so  much  the  richer  that  a  day's  labor  will  produce  from  them 
twice  as  much  steel  as  a  day's  labor  will  produce  from  the 
deposits  of  the  densely  settled  region.  Enterprisers  of  the 
former  region  will  have  to  pay  miners,  furnacemen,  etc.,  at 
least  as  much  as  they  could  earn  in  agriculture  —  the  price 


INTERNATIONAL  TRADE  AND  FOREIGN  EXCHANGE  337 

of  five  bushels  a  day.  Enterprisers  in  the  region  of  dense 
population  will  also  pay  wages  gauged  by  the  returns  to 
agricultural  labor —  the  price  of  one  bushel  a  day.  A  simple 
calculation  will  show  that  steel  manufacturers  in  the  region 
of  dense  population  can  produce  steel  much  more  cheaply 
than  their  competitors  in  the  other  region. 

In  order  to  make  our  example  correspond  more  closely 
with  reahty,  we  should  need  to  substitute,  for  steel  mak- 
ing only,  a  wide  range  of  industries,  mainly  manufactur- 
ing ;  for  wheat  raising  we  should  substitute  a  wide  range 
of  industries,  mainly  extractive.  We  might  then  say,  with 
perfect  truth,  that  in  a  sparsely  settled  region  the  margi- 
nal productivity,  and  consequently  the  wages  of  labor,  are 
likely  to  be  so  high  that  manufactures  cannot  be  carried 
on  profitably  in  competition  with  a  densely  settled  region, 
where  the  marginal  productivity  of  labor,  and  hence  wages, 
are  low.  American  manufacturers  of  iron  and  steel  prod- 
ucts have  for  a  century  been  forced  to  pay  higher  wages 
than  English  manufacturers,  largely  because  the  produc- 
tivity of  labor  in  agriculture  was  so  much  higher  here 
than  in  England. 

13.    Trade  bctzvcen  different  countries  is  essentially  barter. 

In  early  times,  interregional  trade,  like  all  other  forms 
of  trade,  was  carried  on  through  barter.  The  Phoenician 
merchant,  we  may  safely  assume,  carried  to  each  port 
commodities  that  he  thought  would  be  in  demand  there, 
and  bartered  them  for  commodities  which  he  desired.  In 
a  later  stage  money  was  employed,  but  chiefly  for  effect- 
ing exchanges  within  a  single  locality.  The  artisan  mer- 
chants of  the  mediaeval  Hanse  towns  trading  with  England 
carried  cloth  and  other  wares  to  London  and  exchanged 
them  for  wool  and  other  English  products.  Doubtless 
when  in  England  the  Hanse  merchants  often  iirst  ex- 
changed their  wares  for  local  currency,  and  exchanged 
the  currency  in  turn  for  goods  to  carry  back  to  Germany, 


338  INTRODUCTION    TO    ECONOMICS 

From  the  point  of  view  of  the  two  tradingregions,  the  trade 
was  an  exchange  of  goods  for  goods,  or  barter,  in  spite  of 
the  employment  of  currency  in  England. 

In  a  later  stage  the  importation  of  goods  is  partly  di- 
vorced from  the  exportation  of  goods.  Men  having  goods 
that  they  believe  will  fetch  a  high  price  in  a  foreign  mar- 
ket ship  them  abroad,  expecting  to  receive  the  price  of  the 
goods  in  the  form  of  gold  and  silver.  Men  wishing  to 
buy  foreign  goods  send  gold  and  silver  in  payment  for 
them.  Hence,  exportation  and  importation  of  the  precious 
metals  may  be  often  carried  on  concurrently,  at  a  consider- 
able risk  and  expense.  Here  obviously  is  opportunity  for 
the  development  of  a  system  of  set-offs,  to  reduce  the 
transmission  of  the  precious  metals  between  the  two  trad- 
ing regions  to  a  mere  settlement  of  balances.  By  this 
system,  which  long  ago  reached  a  high  degree  of  develop- 
ment, international  trade  is  reduced  practically  to  barter  — 
exchange  of  commodities  for  commodities. 

14.  TJie  use  of  gold  in  intcniational  payments  is  largely 
obviated  by  tlie  employment  of  bills  of  exchange. 

Let  us  suppose  that  A,  a  New  York  exporter,  has  sold 
10,000  bushels  of  wheat  to  X,  a  Liverpool  importer,  at 
the  price  of  ^i  a  bushel.  If  he  wishes  the  $10,000  deliv- 
ered to  him  at  New  York,  in  gold,  he  must,  of  course,  pay 
freight  and  insurance  on  it.  This  will  cost  about  $3  for 
every  $500,  or  $60  for  the  entire  sum. 

But  suppose  that  after  shipping  the  wheat,  and  before 
giving  orders  for  the  delivery  of  the  gold,  he  meets  B,  a 
New  York  importer,  who  is  about  to  order  $10,000  worth  of 
woolen  goods  from  Y,  a  Liverpool  exporter.  If  B  were  to 
ship  the  $ro,ooo  in  gold  to  Liverpool,  it  would  cost  him 
$60  for  freight  and  insurance.  Now,  if  A  will  give  B  an 
order  instructing  X  to  pay  Y  the  $10,000,  instead  of  re- 
mitting it  to  himself,  B  can  pay  A  the  $10,000  that  he 
would  otherwise  have  remitted  to  Y.     Both  debts  will  be 


INTERNATIONAL  TRADE  AND  FOREIGN  EXCHANGE  339 

extinguished  by  such  an  arrangement,  and  both  A  and  B 
can  save  $60  by  it. 

Such  an  order  as  we  have  assumed  that  A  gives  to  B,  re- 
questing X  to  pay  Y  a  certain  sum  originally  due  to  A,  is 
known  as  a  bill  of  exchange.  Such  a  bill  may  be  payable 
as  soon  as  it  is  presented  to  the  person  upon  whom  it  is 
drawn,  or  it  may  be  payable  after  the  expiration  of  a 
period  of  time  —  twenty,  thirty,  sixty  days.  In  the  for- 
mer case  it  is  a  "sight  bill,"  in  the  latter  a  "time  bill." 
Time  bills  usually  bear  interest  —  a  fact  that  assimilates 
them  to  other  credit  instruments,  but  has  no  bearing  on 
the  principles  of  exchange.  We  shall  therefore  assume 
that  bills  of  exchange  are  sight  bills  only. 

In  our  example  it  appeared  that  both  A  and  B  gained 
$60  by  the  arrangement.  Now,  if  B  had  been  unwilhng, 
for  some  reason,  to  give  A  $10,000  for  the  latter's  bill  of 
exchange,  A  might  have  taken  less.  It  would  have  been 
more  profitable  for  him  to  take  $9950  than  to  incur  the 
expense  of  importing  the  gold.  If  B  had  offered  $9940, 
it  would  have  been  a  matter  of  indifference  to  A  whether 
he  sold  his  bill  to  B  or  imported  the  gold.  $9940  is  evi- 
dently the  very  lowest  price  at  which  the  bill  would  be 
sold.  On  the  other  hand,  if  A  had  been  unwilling  to 
part  with  his  bill  for  just  $10,000,  B  might  have  offered 
more,  for  he  could  better  have  afforded  to  pay  $10,050 
for  the  bill  than  stand  the  expense  of  exporting  gold.  If 
A  had  demanded  $10,060,  it  would  have  been  a  matter  of 
indifference  to  B  whether  he  bought  the  bill  or  shipped 
the  gold.  $10,060  is,  then,  the  very  highest  price  that  a 
$10,000  bill  can  be  made  to  fetch. 

15.  Bills  of  exchange  sell  at  par  when  the  sitpply  of  them 
just  equals  the  demand.  When  the  supply  is  less  than  the 
demand,  they  rise  above  par ;  when  the  supply  exceeds  the 
demand,  they  fall  below  par. 

When  a  bill  of  exchange  sells  for  just  its  face  value,  it  is 


340  INTRODUCTION  TO   ECONOMICS 

said  to  be  at  par  ;  when  for  more  or  less,  it  is  above  or  below 
par.  We  have  now  to  inquire  under  what  conditions  bills 
will  be  at  par,  or  above  or  below  par. 

If  the  importer  whom  we  designated  as  B  thinks  that 
the  chances  are  good  that  he  can  find  other  exporters  be- 
sides A  who  are  anxious  to  dispose  of  bills  of  exchange,  he 
is  likely  to  offer  less  than  par  for  A's  bill.  If  one  of  the 
holders  of  bills  will  not  sell  at  a  low  price,  another  probably 
will.  If,  on  the  other  hand,  A  thinks  that  he  can  easily 
find  other  persons  besides  B  who  have  payments  to  make 
abroad,  and  who  are  anxious  to  purchase  bills  for  the  pur- 
pose, he  is  likely  to  hold  his  bill  at  a  price  above  par.  In 
general  terms,  when  the  volume  of  bills  offered  for  sale 
appears  to  exceed  the  volume  of  remittances  to  be  made  to 
a  foreign  center,  bills  fall  below  par.  When  the  volume  of 
bills  appears  to  be  inferior  to  the  volume  of  remittances  to 
be  made,  bills  rise  above  par.  In  the  former  case,  each 
holder  of  a  bill  knows  that  some  bills  cannot  be  sold  at 
all ;  their  holders  will  have  to  go  to  the  expense  of  import- 
ing specie.  Rather  than  be  left  in  this  position  himself,  he  is 
willing  to  sell  his  bill  at  less  than  its  par  value,  provided  that 
the  price  offered  is  not  so  low  that  to  bear  the  cost  of  import- 
ing specie  would  be  a  lesser  evil.  In  the  latter  case  each 
person  having  remittances  to  make  knows  that  some  men 
will  have  to  go  to  the  expense  of  exporting  specie.  Hence 
each  one  will  offer  more  than  its  par  value  for  a  bill  of 
exchange. 

16.  When  all  the  payments  that  otie  tradi)ig  region  mnst 
make  to  another  equal  the  payments  to  be  made  by  the  latter 
region  to  the  former,  the  supply  of  bills  equals  the  demand, 
and  exchange  is  at  par. 

iVe  must  now  endeavor  to  determine  the  conditions  un- 
der which  the  volume  of  bills  equals,  is  superior  to,  or  in- 
ferior to,  the  volume  of  remittances.  We  shall  assume 
that  the  relations  between  the  United  States  and   Great 


INTERNATIONAL  TRADE  AND  FOREIGN  EXCHANGE  341 

Britain  are  carried  on  without  regard  to  relations  with 
other  countries,  and  that  American  business  is  all  handled 
through  New  York,  British  through  London. 

The  United  States,  we  will  assume,  exports  in  one  year 
products  worth  $500,000,000  to  Great  Britain,  and  Great 
Britain  exports  products  worth  $250,000,000  to  the  United 
States.  Under  the  head  of  exports  and  imports,  we  shall 
have  bills  on  London  aggregating  $500,000,000,  and  remit- 
tances to  make  aggregating  only  $250,000,000. 

Citizens  of  the  United  States  still  owe  vast  sums  to  citi- 
zens of  Great  Britain  ;  citizens  of  Great  Britain  owe  lesser 
sums  to  citizens  of  the  United  States.  Interest  on  these 
debts  will  be  transmitted  by  way  of  exchange.  Let  us  say 
that  Great  Britain  must  pay  us  $5,000,000,  while  we  must 
pay  Great  Britain  $75,000,000.  This  will  add  $5,000,000 
to  the  total  volume  of  bills,  and  $75,000,000  to  the  aggre- 
gate of  remittances. 

Some  American  borrowers  are  paying  off  their  debts  to 
British  capitaUsts;  others  are  borrowing  fresh  capital.  The 
sum  of  payments  at  present  probably  greatly  exceeds  the 
sum  of  new  loans.  We  will  put  the  former  at  $130,000,000, 
the  latter  at  $25,000,000.  Under  this  head,  then,  we  may 
add  $25,000,000  to  the  volume  of  bills,  $130,000,000  to  the 
volume  of  remittances. 

Americans  living  or  traveling  in  England  must  have 
their  incomes  sent  them  from  here;  Englishmen  living  or 
traveling  here  must  have  their  incomes  sent  from  England. 
Let  us  suppose  that  we  must  send  $15,000,000  to  our  citizens 
in  England ;  England  must  send  $5,000,000  to  her  citizens 
here.  This  would  add  another  $5,000,000  to  the  volume  of 
bills,  $15,000,000  to  the  volume  of  remittances. 

Most  of  our  trade  with  Great  Britain  is  carried  on  by 
British  ships.  We  must,  of  course,  pay  for  the  service,  and 
our  payments  must  be  sent  to  Great  Britain.  We  will  place 
the  aggregate  at  $75,000,000.     What  we  carry  for  Great 


342  INTRODUCTION    TO    ECONOMICS 

Britain  is  too  little  to  take  into  account.  So  we  must  add 
;^75, 000,000  to  the  volume  of  remittances  without  any  off- 
setting increase  in  the  volume  of  bills. 

DUE   THE    UNITED   STATES  DUE   GREAT   BRITAIN 

Exports  $500,000,000       $250,000,000 

Interest 5,000,000       75,000,000 

Proceeds    of    new  Repayment   of    old 

loans 25,000,000  loans 130.000,000 

British    travelers'    ex-  American     travelers' 

penses 5,000,000  expenses 1 5,000,000 

Payment    for  ocean 

transportation 75,000,000 

$535,000,000  $535,000,000 

Footing  up  the  assumed  items  of  indebtedness,  we  find 
that  the  United  States  can  draw  bills  to  the  amount  of 
$535,000,000,  and  must  make  remittances  to  the  amount  of 
$535,000,000.  Exxhange  on  London  will  be  at  par  under 
these  conditions. 

Of  course,  it  is  rarely  the  case  that  the  payments  to  be, 
made  between  two  countries  exactly  balance.  At  one  time 
the  balance  is  in  favor  of  one  country,  at  another  time  in 
favor  of  the  other.  When  our  claims  upon  Great  Britain 
exceed  the  claims  of  Great  Britain  upon  us,  bills  drawn  on 
London  are  below  par.  When  we  owe  Great  Britain  more 
than  is  due  us  from  Great  Britain,  London  exchange  is 
above  par. 

17.  TJie  price  of  exchange  on  London  depends  upon  the 
balance  of  indebtedness  between  the  United  States  and  all 
foreign  countries,  not  upon  the  balance  of  indebtedness  between 
the  United  States  and  Great  Britain  alone. 

For  simplicity  we  assumed  that  the  exchange  relations 
between  the  United  States  and  England  were  not  compli- 
cated by  relations  with  other  countries.  This  assumption 
we  must  now  abandon.  The  United  States  buys  coffee 
from    Brazil.     Brazil   buys    manufactures    from    England. 


LNTERNATIONAL  TRADE  AND  FOREIGN  EXCHANGE  343 

England  buys  wheat  from  the  United  States.  Now,  it  is  evi- 
dent that  BraziHan  coffee  exporters  will  be  glad  to  accept 
from  American  importers  bills  of  exchange  drawn  on  Lon- 
don, as  these  bills  will  be  in  demand  among  Brazilian  im- 
porters of  British  manufactures. 

If  the  sums  that  Americans  must  remit  directly  to 
England  aggregate  $300,000,000,  and  the  sums  that  Eng- 
land must  pay  directly  to  the  United  States  aggregate 
$325,000,000,  bills  drawn  on  London  may  yet  be  above  par. 
For  American  coffee  importers  may  need,  say,  $40,000,000 
in  bills  on  London  to  make  payments  in  Brazil.  Li  this 
case,  the  remainder  of  the  volume  of  bills  will  not  be  suffi- 
cient to  meet  the  demand  for  them,  and  they  will  go  above 
par. 

Even  if  the  Brazilians  imported  nothing  from  England, 
bills  drawn  on  London  would  nevertheless  be  acceptable  to 
them  as  means  of  payment  for  their  exports.  Brazil  must 
import  from  some  country,  and  that  country,  in  all  probabil- 
ity, has  payments  to  make  in  England,  and  so  will  accei)t 
bills  on  London  in  preference  to  gold.  This  follows  from 
the  fact  that  England  has  for  a  century  been  the  financial 
and  commercial  center  of  the  world.  The  whole  world  deals 
with  England.  Hence  bills  of  exchange  drawn  on  London 
have  become  a  favorite  medium  of  international  payments 
throughout  the  world.  If  you  wish  to  remit  money  to  a 
missionary  in  China  or  to  a  stockman  in  Patagonia,  you  will 
probably  do  it  through  exchange  on  London.  Similarly, 
if  Chinese  or  Patagonians  have  remittances  to  make  to  you, 
they  will  employ  exchange  on  London  for  the  purpose. 

Accordingly,  the  demand  for  bills  on  London  is  prac- 
tically equal  to  the  whole  volume  of  payments  to  be  made 
by  Americans  to  persons  living  outside  of  the  United 
States;  the  supply  of  bills  amounts  practically  to  the 
aggregate  payments  to  be  made  by  such  persons  to  Ameri- 
cans.    When  we  must  pay  foreigners  exactly  as  much  as 


344  INTRODUCTION   TO   ECONOMICS 

they  must  pay  us,  exchange  on  London  is  about  at  par. 
When  the  balance  of  payments  is  in  our  favor,  exchange 
is  below  par ;  when  the  balance  is  against  us,  it.  is  above 
par.  Naturally,  exchange  on  London  is  expressed  in  terms 
of  the  British  currency  —  pounds  sterling.  When  ex- 
change is  at  par,  the  pound  sterling  is  quoted  at  $4.86|. 
When  exchange  is  above  par,  an  American  who  wishes  to 
remit  a  pound  sterling  to  England  must  pay  more  than 
$4.86^  for  it  —  perhaps  ^4.88.  If  the  price  of  a  pound 
sterling  (exchange)  rises  above  $4.89!,  it  pays  better  to 
ship  gold.  The  point  at  which  all  advantage  in  employing 
bills  of  exchange  instead  of  gold  ceases,  is  known  as  the 
gold  point.  If  the  price  of  the  pound  sterling  declines  to 
$4.83!,  it  pays  holders  of  bills  to  send  them  over  to  Eng- 
land for  collection,  with  orders  that  the  gold  be  shipped  to 
America.     ^4.83!  is  therefore  also  known  as  a  gold  point. 

18.  //  otJicr  items  of  international  payments  remain  nn- 
changed,  the  pi  iee  of  bills  of  exchange  is  loivered  by  an  in- 
crease in  exports  or  a  decrease  in  imports  ;  it  is  raised  by  a 
decrease  in  exports  or  an  increase  in  imports. 

If  we  assume  that  other  items  of  international  payments 
(transmission  of  capital,  interest  payments,  travelers'  ex- 
penses, payments  for  ocean  transportation)  remain  con- 
stant, it  follows  that  fluctuations  in  exchange  follow 
fluctuations  in  exports  and  imports.  If  we  increase  our 
exports,  imports  remaining  unchanged,  the  supply  of  bills 
increases,  and  their  price  tends  to  fall.  If  we  increase  our 
imports,  exports  remaining  the  same,  the  volume  of  remit- 
tances to  be  made  increases,  and  exchange  rises  in  price. 

19.  Fhictnations  in  the  rate  of  exchange  tend  to  bring 
about  a  balance  of  international  payments,  through  stimulat- 
ing exports  and  discouraging  imports,  tvhen  exchange  is  above 
par,  and  through  discouraging  exports  and  stimulating  im- 
ports when  exchange  is  beloiv  par. 

When  bills  are  above  par,  it  is  more  than  usually  prof- 


LNTERNATIONAL  TRADE  AND  FOREIGN  EXCHANGE  345 

itable  to  export  goods.  Let  us  suppose  that  in  New  York 
the  price  of  wheat  is  ninety-four  cents  a  bushel,  while  in 
England  the  price  is  $1.  If  it  costs  five  cents  a  bushel  to 
ship  wheat  from  New  York  to  England,  the  exporter  will 
make  $100  on  a  10,000  bushel  shipment,  if  exchange  is  at 
par.  If  exchange  is  at  its  maximum  above  par,  the  exporter 
will  be  able  to  sell  his  $10,000  bill  for  $10,060,  thusaddinp- 
$60  to  his  nominal  profit  of  $100.  If  exchange  is  at  its 
minimum  below  par,  the  exporter  can  get  only  $9940  for 
his  $10,000  bill,  thus  losing  $60  of  his  nominal  profit  of 
$100.  If  a  profit  of  $100  on  10,000  bushels  is  just  suffi- 
cient to  induce  exporters  to  ship  wheat,  no  wheat  will  be 
shipped  if  exchange  is  below  par. 

When  exchange  is  below  par,  it  is  more  than  usually 
profitable  to  import  goods.  Let  us  suppose  that  it  barely 
pays  to  import  a  certain  kind  of  woolen  goods  when  ex- 
change is  at  par ;  that  under  these  conditions  the  importer 
makes  only  $100  on  a  $10,000  shipment.  If  exchange  is 
at  its  lowest  price,  the  importer  can  pay  for  his  goods  with 
a  $10,000  bill  costing  only  $9940.  Thus  he  adds  $60  to 
his  profits.  If  exchange  is  at  its  highest  price,  and  the  im- 
porter must  pay  $10,060  for  a  $10,000  bill,  $60  is  deducted 
from  his  profit,  and  the  business  ceases  to  be  worth  while. 

It  follows  that  there  is  a  tendency  for  an  excess  of  either 
exports  or  of  imports  to  check  itself.  If  our  exports  in- 
crease, other  things  equal,  exchange  falls,  and  this  dis- 
courages further  exports,  but  encourages  imports.  If  our 
imports  increase  too  rapidly,  exchange  rises,  and  this  dis- 
courages further  imports  and  encourages  exports. 

The  fluctuations  of  the  rate  of  exchange,  then,  have  a 
tendency  to  create  a  balance  of  exports  and  imports  —  al- 
lowance made  for  other  items  of  international  indebtedness. 
Exports  and  imports,  in  the  long  run,  must  increase  or  de- 
cline together. 

20.    If  the  difference  in  the  general  price  level  between 


346  INTRODUCTION   TO   ECONOMICS 

two  countries  is  so  great  that  fluctuations  iji  the  price  of  bills 
of  exchange  cajuiot  bring  about  a  balance  of  payments,  gold 
floivs  from  the  one  country  to  the  other  until  the  price  level 
becomes  practically  the  same  for  both. 

But  suppose  that  the  margin  between  prices  in  two  coun- 
tries is  so  wide  that  it  pays  to  export  in  spite  of  a  low 
price  for  exchange,  or  to  import  in  spite  of  a  high  price. 
In  the  former  case,  gold  must  be  imported  to  pay  for  the 
exports  ;  in  the  latter,  gold  must  be  exported  to  pay  for  the 
imports.  Now,  we  saw  in  an  earlier  chapter  that  an  in- 
crease in  the  supply  of  money  tends  to  raise  prices ;  a 
reduction  of  the  money  supply  causes  prices  to  fall.  If, 
then,  our  prices  are  so  low  that  men  find  it  profitable  to 
send  an  excess  of  commodities  abroad  for  sale,  to  be  paid 
for  in  gold,  the  condition  must  be  transitory.  For  as  the 
gold  flows  into  the  country,  prices  rise,  and  the  exporters* 
gains  grow  smaller  and  smaller.  If,  on  the  other  hand, 
general  prices  here  are  so  high  that  it  pays  importers  to 
bring  into  the  country  vast  amounts  of  goods,  to  be  paid 
for  by  exportation  of  gold,  the  condition  must  be  equally 
transitory.  With  the  efflux  of  gold,  prices  fall,  and  the 
profits  of  importers  dwindle  away.  In  the  end  more 
of  our  commodities  become  cheap  enough  to  export; 
and  so  the  balance  between  exports  and  imports  is  re- 
stored. 

There  are  men  who  hold  that  the  United  States  should 
endeavor  to  increase  its  exports,  but  systematically  dis- 
courage importation.  It  is  obvious  that  such  a  policy  would 
be  futile.  If  our  exports  increase,  our  imports  will  neces- 
sarily increase  also,  and  vice  versa.  The  fluctuations  in  the 
price  of  foreign  exchange,  and  the  effects  of  influx  or  efflux 
of  gold,  insure  this  result.  Exports  and  imports  are  indis- 
solubly  united  by  natural  law ;  governments  can  destroy 
both,  but  no  policy  can  be  successful  which  aims  to  foster 
the  one  while  persecuting  the  other. 


INTERNATIONAL  TRADE  AND  FOREIGN  EXCHANGE  347 

21.    Sunnnary. 

Trade,  both  domestic  and  international,  is  based  upon 
differences  in  productive  powers.  The  trade  between  two 
nations  may  arise  from  the  fact  that  each  possesses  exclu- 
sive powers  of  producing  certain  commodities ;  or  it  may 
arise  from  the  fact  that  each  is  superior  to  the  other  in 
some  particular  branch  of  production.  The  differences  in 
productive  powers  upon  which  international  trade  is  based 
may  be  due  to  differences  in  the  character  of  population, 
differences  in  traditions  of  workmanship,  differences  in 
natural  endowment,  or  differences  in  supply  of  capital. 
Of  these  differences  some  tend  to  disappear  with  lapse  of 
time,  while  others  constantly  increase  in  importance. 

A  country  may  profitably  import  commodities  for  the 
production  of  which  it  possesses  natural  advantages  supe- 
rior to  those  of  the  exporting  country.  This  is  often  the 
case  when  the  marginal  productivity  of  labor  and  capital, 
and  hence  money  cost  of  production,  is  higher  in  the 
former  country  than  in  the  latter. 

The  trade  between  two  countries  is  carried  on  through 
the  mechanism  of  exchange.  Gold  payments  are  reduced 
to  a  mere  settlement  of  balances ;  hence  it  may  be  said 
that  international  trade  is  essentially  barter. 

When  exports  exceed  imports,  other  things  equal,  ex- 
change falls  below  par ;  and  this  tends  to  encourage 
importation  and  discourage  exportation.  When  imports 
exceed  exports,  exchange  rises  above  par ;  and  this  tends 
to  encourage  exportation  and  discourage  importation. 
Thus  fluctuations  in  the  rate  of  exchange  tend  to  bring 
about  an  even  balance  of  exports  and  imports.  If  for  any 
reason  the  balance  of  trade  inclines  persistently  in  one 
direction  or  the  other,  gold  is  imported  or  exported,  and 
this,  through  affecting  prices  both  domestic  and  foreign, 
ultimately  establishes  an  even  balance  of  international 
exchange. 


CHAPTER   XIX 

THE  REGULATION   OF  FOREIGN  TRADE 

1.  Foreign  trade  is  subjected  to  govern-mental  regulation 
chiefly  under  the  form  of  taxation. 

Since  early  modern  times  a  great  part  of  the  energy 
of  governments  has  been  expended  upon  the  regulation  of 
international  trade.  The  reason  for  such  regulation  has 
been  twofold.  In  the  first  place,  there  is  a  deep-rooted 
belief  in  the  people  of  every  nation  that  the  national  pros- 
perity may  be  furthered  by  restrictions  upon  trade  with 
foreigners.  In  the  second  place,  such  trade  has  long 
been  recognized  as  a  convenient  and  appropriate  source 
of  public  revenue. 

A  century  ago  the  policy  of  prohibiting  the  importation 
of  some  classes  of  goods,  and  the  exportation  of  other 
classes,  was  widely  followed.  At  present  this  policy  has 
practically  fallen  into  disuse.  Some  of  the  states  of  east- 
ern Europe  prohibit  the  exportation  of  grain  when  the 
supply  appears  to  be  insufficient  to  keep  the  people  of 
those  states  from  starving.  Most  countries  prohibit  the 
importation  of  certain  commodities  that  are  believed  to 
menace  the  health  of  the  consumer.  Omitting  such  ex- 
ceptional cases,  however,  we  may  say  that  the  regulation 
of  foreign  trade  is  everywhere  carried  on  under  the  guise 
of  taxation.  If  we  wish  to  prohibit  the  importation  of  cot- 
ton from  Egypt,  we  place  such  high  taxes  upon  imports 
of  Egyptian  cotton  that  no  one  finds  it  worth  while  to 
import  it. 

Taxes  on  foreign  trade  may  be  levied  upon  either  im- 
ports or  exports  or  upon  both.  Export  taxes  are  generally 
unpopular,  because  of  the  common  belief  that  it  is  a  good 

348 


THE  REGULATION  OF  FOREIGN  TRADE    349 

thing  to  export  as  many  goods  as  possible.  In  the  United 
States  export  taxes  are  prohibited  by  the  Constitution. 
We  shall  therefore  confine  our  study  to  taxes  on  imports. 

2.  Import  taxes,  or  '''  duties,''  may  be  levied  for  the  sole 
purpose  of  raising-  a  revenue,  or  for  the  purpose  of  discour- 
aging the  importation  of  commodities  of  classes  that  can 
be  produced  ivithin  a  country.  Taxes  levied  for  the  former 
purpose  are  called  revenue  duties ;  taxes  levied  for  the  latter 
purpose  are  called  protective  duties. 

Before  the  annexation  of  Porto  Rico  all  the  coffee  used 
in  the  United  States  came  from  foreign  soil.  A  tax  (or 
*'  duty  ")  of,  say,  five  cents  a  pound  under  the  conditions 
would  have  discouraged  importation  in  only  a  slight  de- 
gree. Most  of  us  would  have  used  as  much  coffee,  even 
at  the  higher  price.  A  duty  of  $20  a  ton  on  steel,  on  the 
other  hand,  would  practically  prohibit  the  importation  of 
steel.  For  our  own  steel  industry  can  produce  steel  almost, 
if  not  quite,  as  cheaply  as  that  of  any  foreign  country. 
Suppose  that  we  can  produce  steel  at  $15  a  ton  while  in 
some  foreign  country  it  can  be  produced  at  $12.  If  the 
cost  of  bringing  steel  from  the  foreign  country  is  $2  a  ton, 
foreign  producers  can  sell  steel  here  at  lower  prices  than 
our  own  producers  can  afford  to  take.  But  if  foreign  steel 
is  compelled  to  pay  a  duty  of  $20  a  ton,  none  of  it  can  be 
sold  here,  unless  the  American  producers  combine  and 
force  steel  up  to  the  price  of  $34  a  ton.  Such  a  duty, 
since  it  "  protects "  domestic  producers  against  foreign 
competition,  is  known  as  a  protective  duty. 

All  duties  levied  upon  imported  goods  of  a  character 
that  cannot  be  produced  in  a  country  may  be  classed  to- 
gether as  pure  revenue  duties.  All  duties  levied  on  goods 
of  a  character  that  can  be  produced  in  a  country  are  pro- 
tective duties.  Of  course  a  duty  the  aim  of  which  is  the 
raising  of  revenue  may  be  incidentally  protective.  Thus 
if  we  were  to  levy  a   duty  on  imported  coffee,  it  would 


15° 


INTRODUCTION   TO    ECONOMICS 


"protect"  the  coffee  growers  of  Porto  Rico.  On  the 
other  hand,  protective  duties  may  incidentally  yield  a  rev- 
enue. In  the  case  employed  above,  if  the  duty  on  foreign 
steel  had  been  $i  instead  of  $20,  foreign  steel  would 
have  continued  to  be  imported,  and  thus  a  revenue  would 
have  been  obtained.  At  the  same  time  the  foreigner 
would  have  been  prevented  from  underselling  the  Ameri- 
can ;  accordingly,  the  latter  would  have  been  "  protected." 
Most  of  our  duties  are  protective,  but  incidentally  yield  a 
revenue,  as  they  are  not  high  enough  to  prevent  importa- 
tion altogether. 

The  schedule  of  all  duties  levied  by  a  country  is  known 
as  the  "  tariff."  A  tariff  consisting  of  duties  whose  main 
object  is  the  raising  of  a  revenue  is  known  as  a  revenue 
tariff.  Such  a  tariff  has  long  been  in  force  in  England. 
A  protective  tariff  consists  mainly  of  duties  whose  purpose 
is  the  protection  of  domestic  producers  against  foreign  com- 
petition. Such  a  tariff  has  been  in  force  in  the  United 
States  since  early  in  the  nineteenth  century  ;  its  character 
has  been  most  strongly  marked  since  the  Civil  War. 

3.  Revenue  duties  on  imports  are  among  the  most  conven- 
ient and  popiilar forms  of  taxation,  partly  because  the  tax- 
payer does  not  realize  how  heavy  the  taxes  are,  and  partly 
because  of  the  common  belief  that  such  taxes  are  borne  by  the 
foreigners  ivho  export  the  goods. 

Every  government  needs  large  funds  for  the  mainte- 
nance of  the  numerous  corps  of  officials  and  servants  making 
up  its  civil  and  military  establishments  and  for  the  meeting 
of  other  expenses  incurred  in  the  discharge  of  its  various 
functions.  These  funds  must  be  obtained  chiefl}^  through 
taxation.  Two  methods  of  raising  taxes  are  open  to  the 
government.  It  may  send  its  officials  to  each  man's  house, 
and  levy  upon  his  person  or  property.  In  this  case  it  is 
said  to  levy  direct  taxes.  The  government  may,  on  the 
Other  hand,  impose  taxes  upon  salable  commodities  as  they 


THE    REGULATION    OE    EOREIGN   TRADE         351 

are  found  in  the  hands  of  producers  or  dealers.  The  latter 
then  add  the  tax,  in  whole  or  in  great  part,  to  the  selling 
price  of  the  coninioditics  taxed.  The  buyer  of  the  com- 
modities thus  bears  ultimately  all  or  the  greater  part  of  the 
tax.     Such  taxes  are  said  to  be  indirect. 

For  such  obvious  and  imperative  needs  of  government 
as  the  construction  of  highways,  the  maintenance  of  courts 
and  schools,  the  average  citizen  is  willing  to  pay  direct  taxes, 
although  he  usually  cpiarrels  with  the  amount  imposed  upon 
him.  The  benefits  to  be  derived  from  a  standing  army  or 
a  navy  are  more  remote,  and  the  taxpayer  would  be  far  less 
willing  to  contribute  directly  to  their  support  than  to  the 
support  of  local  government  institutions.  For  this  reason, 
national  governments  rely  largely  upon  indirect  taxes.  The 
average  citizen  has  no  very  clear  idea  as  to  the  amount 
of  taxes  he  pays  in  this  way.  Whenever  you  buy  a  pound 
of  imported  sugar  (and  most  of  our  sugar  is  imported)  you 
pay  a  tax.  Whenever  you  buy  English  woolens  or  cottons 
or  French  silks,  you  are  taxed.  If  you  use  tobacco  in  any 
form,  or  spirituous,  malt,  or  vinous  liquors,  you  pay  taxes 
on  them.  And  so  with  a  host  of  other  commodities.  How 
great  is  the  aggregate  yearly  sum  that  you  contribute  to 
government  in  indirect  taxes .''  You  probably  have  not 
the  least  idea.  But  this  is  certain  ;  if  the  entire  amount 
were  collected  from  you  in  cash  at  one  time,  you  would 
feel  that  this  government  of  ours  is  an  expensive  luxury. 
Statesmen  would  find  much  greater  difficulty  in  convinc- 
ing you  that  we  should  have  the  greatest  navy  afloat,  or 
that  we  should  hold  ourselves  in  readiness  to  enter  upon  a 
^2,000,000,000  war  over  a  $200  matter. 

Of  all  indirect  taxes,  those  levied  on  foreign  trade  are  the 
most  convenient.  All  foreign  goods  must  cross  the  national 
frontier,  where  there  are  always  officials  and  soldiers  whose 
services  can  be  employed  in  preventing  goods  from  being 
secretly  carried  into  the  country.     A  few  points  through 


352  INTRODUCTION   TO    ECONOMICS 

which  such  goods  must  pass  may  be  designated  ;  a  compara 
tively  small  body  of  officials  may  be  stationed  at  these  points 
to  levy  and  collect  the  taxes. 

Another  reason  for  the  popularity  of  taxes  on  imports 
is  that  many  persons  believe  that  such  taxes  are  borne  by 
foreigners.  If  we  tax  British  woolens,  French  silks,  and 
German  sugar,  are  we  not  compelling  the  British,  French, 
and  Germans  to  help  pay  the  expenses  of  conducting  our 
government  ? 

4.  Import  duties  are,  as  a  rule,  borne  by  the  consumer,  not 
by  the  importer  nor  by  the  producer. 

Let  us  say  that  a  given  grade  of  woolen  goods  is  pro- 
duced in  England  at  a  cost  of  fifty  cents  a  yard.  Under 
the  laws  of  competitive  industry,  the  cloth  sells  in  England 
for  very  nearly  fifty  cents.  If  the  cost  of  bringing  it  to 
this  country  is  one  cent  a  yard,  and  there  is  no  tax  to 
pay  on  imports,  the  cloth  will  sell  here  for  about  fifty-one 
cents.  Now  if  we  place  a  duty  of  fifty  cents  a  yard  on  the 
cloth,  none  of  it  will  be  sold  here  for  less  than  the  British 
price  plus  the  cost  of  transportation  plus  the  tax,  or  a  dollar 
and  one  cent.  The  man  who  buys  the  goods  for  use  pays 
the  tax,  in  the  last  instance.  And  so  with  most  import 
duties.  There  are  exceptional  cases  in  which  the  whole 
amount  of  the  duty  cannot  be  added  to  the  original  price 
of  imported  goods.  In  these  cases  the  foreign  producer 
may  be  said  to  bear  part  of  the  tax.  As  a  general  rule, 
however,  the  consumer  of  the  goods  pays  the  tax,  although 
he  may  not  be  conscious  of  the  fact. 

5.  Protective  duties  are  sometimes  advocated  as  a  means 
of  keeping  money  at  home. 

A  revenue  tariff  needs  no  defense.  A  state  must  have 
revenues,  and  there  is  no  easier  way  of  collecting  them  than 
through  import  duties  on  commodities  that  we  cannot  our- 
selves produce.  A  protective  tariff,  on  the  other  hand,  re- 
quires more  extended  consideration.    It  is  designed  to  foster 


THE    REGULATION    OF    FOREIGN   TRADE         353 

domestic  industry  at  the  expense  of  the  business  of  impor- 
tation. Whether  it  does  this  or  not  is  a  question  of  great 
importance.  We  must  see  exactly  how  such  a  tariff  affects, 
not  merely  isolated  branches  of  industry,  but  the  industry 
of  a  nation  as  a  whole. 

There  is  a  very  primitive  view,  unfortunately  yet  far 
from  extinction,  that  it  is  an  evil  thing  to  buy  anything  from 
foreign  producers  —  even  the  things  that  cannot  be  pro- 
duced in  the  country  at  all.  Those  who  hold  to  this  view 
imagine  that  we  must  send  abroad  money  to  pay  for  all  pur- 
chases, and  money,  they  say,  should  be  kept  at  home.  We 
saw  in  the  last  chapter  that  the  medium  through  which  in- 
ternational payments  are  effected  is,  in  a  vast  majority  of 
cases,  bills  of  exchange.  The  shipping  of  gold  from  country 
to  country  is  reduced,  by  the  mechanism  of  exchange,  to  very 
small  proportions.  Now,  the  bills  of  exchange  with  which 
we  pay  for  our  imports  are  really  due  bills,  representing 
the  value  of  commodities  that  we  export.  We  saw  also  that 
if  a  country  for  a  time  imports  more  than  its  exports  will 
pay  for,  bills  on  foreign  points  rise  in  price,  and  this  dis- 
courages further  importation  and  encourages  further  expor- 
tation, until  the  proper  balance  between  imports  and  exports 
is  again  restored.  Accordingly,  we  may  cheerfully  proceed 
to  import  as  large  a  volume  of  commodities  as  we  may  desire. 
We  shall  not  thereby  run  the  risk  of  a  serious  drain  upon 
our  money  supply ;  we  shall  merely  make  preparations  for 
an  unusually  large  and  profitable  export  trade  in  the  near 
future. 

6.  There  is  no  sonnd  reason  for  discouraging'  importation 
from  countries  w/iieh  do  not  take  commodities  in  exchaiige. 

Some  men  who  have  advanced  beyond  the  view  that 
all  importation  of  commodities  is  an  evil  yet  cling  to  the 
belief  that  importation  from  countries  that  do  not  buy  as 
much  from  us  as  we  buy  from  them  is  to  be  discouraged. 
They  argue  that  3uch  trade  must  leave  a  balance  which  we 


354  INTRODUCTION   TO    ECONOMICS 

must  pay  in  gold,  and  this  they  regard  as  a  net  loss.  Not 
many  years  ago  one  of  the  administrative  departments  of 
our  national  government  published  a  report  containing  the 
statement  that  our  losses  from  trade  with  South  America, 
during  the  last  half  century,  exceeded  the  cost  of  the  Civil 
War.  For  we  had  purchased  from  those  countries  billions 
of  dollars'  worth  of  commodities  in  e.xcess  of  their  purchases 
from  us.  Of  course,  the  facts  in  the  case  are,  not  that  we 
have  sent  billions  of  dollars  in  gold  to  South  America,  but 
that  we  have  paid  the  balance  in  bills  on  England.  Eng- 
land buys  more  from  us  than  she  sells  to  us,  and  in  her  turn, 
sells  more  to  South  America  than  she  buys  from  that  region. 
If  ever  our  import  trade  with  South  America  assumes  ab- 
normally large  proportions,  our  export  trade  with  England 
expands  in  sympathy.  It  makes  not  the  slightest  difference 
whether  our  foreign  trade  is  three-cornered,  as  in  this  case, 
or  whether  it  is  carried  on  directly  with  one  other  country. 

7.  TJie  argmnciit  that  the  national  zvcaltJi  is  necessarily 
reduced  zvhen  otic  purchases  from  abroad  commodities  that 
can  be  made  at  home  is  fallacious. 

Slightly  less  shallow  is  the  view  that  one  should  not 
buy  from  foreigners  commodities  that  he  can  obtain  from 
his  fellow-citizens,  even  if  the  latter  demand  higher  prices 
than  foreigners  are  content  to  receive.  If  you  wish  to  buy 
an  automobile,  it  is  urged,  you  should  buy  one  of  American 
make,  even  if  you  can  get  as  good  one  of  French  make  a 
little  cheaper.  By  so  doing  you  will  increase  the  prosperity 
of  the  American  automobile  industry.  You  will  enable  the 
industry  to  employ  more  men  at  higher  wages,  and  to  pay 
higher  dividends  to  those  who  have  invested  their  capital 
in  the  industry.  In  order  that  you  and  the  rest  of  your 
class  may  be  sure  to  lend  your  aid  to  the  American  industry, 
the  government  should  place  a  tax  on  French  automobiles 
imported  into  the  country,  which,  added  to  the  original  price, 
would  make  them  sell  at  higher  prices  than  those  made  in 


THE    REGULATION    OF    FOREIGN   TRADE         355 

this  country.  If  you  then  persisted  in  encouraging  French 
industry  instead  of  that  of  your  own  country  you  would 
have  to  pay  dearly  for  the  privilege. 

The  ulterior  effects  of  a  policy  that  compels  American 
buyers  to  patronize  the  home  industry  are  no  less  happy  (so 
runs  the  familiar  argument).  The  laborers  and  capitalists, 
being  more  prosperous,  have  more  to  spend  on  products  for 
their  own  use.  The  capitalists  erect  mansions  and  the 
laborers  build  cottages,  and  this  creates  employment  for  car- 
penters, masons,  and  other  craftsmen  in  allied  trades.  These 
in  turn  have  more  money  to  spend,  and  increase  their  pur- 
chases of  clothes,  provisions,  and  other  articles  of  use.  And 
so  the  beneficent  effects  of  confining  one's  purchases  of  auto- 
mobiles to  the  American  industry  are  widely  distributed 
throughout  society. 

In  a  similar  way  it  is  urged  that  we  should  buy  all  our 
sugar  from  our  own  producers.  There  is  not  much  doubt 
that  in  ten  years  we  could  extend  our  production  of  sugar 
sufficiently  to  cover  the  demand  for  it,  if  we  would  but  pay 
a  sufficiently  high  price  to  tempt  labor  and  capital  into  the 
industry.  Instead  of  sending  $100,000,000  abroad  to  fruc- 
tify foreign  industry,  we  could  keep  it  at  home  among  our 
own  workingmen  and  capitalists. 

Let  us  see  whether  the  foregoing  argument  will  bear 
close  examination.  Assuming  that  we  import  $100,000,000 
of  sugar  in  a  year,  how  do  we  pay  for  it.-*  Not  with  gold, 
but  with  bills  of  e.xchange  representing  the  value  of  com- 
modities that  we  export. 

Now  suppose  that  we  place  so  high  a  duty  on  sugar 
that  importation  ceases  altogether.  The  immediate  effect 
would  be  a  reduction  in  the  demand  for  foreign  bills  aggre- 
gating $100,000,000  per  annum.  Bills  would,  of  course, 
fall  below  par;  men  exporting  wheat  and  meat  and  cotton 
would  get  less  for  their  products  in  consequence.  The  im- 
portation of  commodities  other  than  sugar  would  be  stimu- 


356  INTRODUCTION  TO   ECONOMICS 

lated,  as  we  have  seen,  by  the  low  price  of  bills.     Exports 
and  imports  would  have  to  be  brought  to  a  balance  again, 
and  this  would  come  to  pass  through  a  shrinkage  of  exports 
and  an  increase  of  imports  other  than  sugar.     Perhaps  we 
should  buy  annually  $50,000,000  more  of  these  other  im- 
ports than  we  did  before,  and  export  $50,000,000  less  of 
wheat,  meat,  and  cotton  than  we  formerly  exported.     The 
producers  of  sugar  are  indeed  benefited  by  the  elimination 
of  foreign  competition,  but  the  producers  of  wheat,  cotton, 
etc.,  are  injured  by  the  reduced  prices  of  exports,  and  the 
producers  of  other  commodities,  partof  the  supply  of  which 
is  imported,  are  injured  by  the  increase  in  importation  of 
those   commodities.     Obviously  enough,  the  evil   ulterior 
effects  of  the  losses  of  these  two  classes  of  producers  cancel 
the  beneficent  ulterior  effects  of  the  gains  of  the  sugar  pro- 
ducers.    The  one  effect  of  the  duty  that  stands  out  with- 
out any  corresponding  offset  is  that  we  shall  pay  ten  cents 
a  pound  for  sugar  instead  of  five  —  certainly  a  result  that 
no  one  can  ardently  desire. 

8.  Protection  of  all  industries  is  an  impossibility. 
But  suppose  that  the  government  places  prohibitive 
duties  on  all  imports.  Will  not  this  place  all  industries 
in  a  position  where  they  may  enjoy  higher  prices.?  And 
in  that  case,  will  it  not  be  as  easy  for  us  all  to  pay  ten 
cents  a  pound  for  sugar  as  it  now  is  to  pay  five }  A  pro- 
tective system,  it  is  often  said,  is  unjust  when  it  singles 
out  a  few  industries  and  grants  them  special  favors.  But 
it  is  just  if  it  favors  all  industries  equally. 

An  obvious  objection  is  that  if  this  were  possible,  if 
each  industry  were  enabled  to  charge  prices  one  hundred 
per  cent  higher,  and  each  person,  accordingly,  received 
twice  as  large  an  income  as  he  would  otherwise  have  re- 
ceived, no  one  would  secure  any  real  benefit  at  all.  If  the 
income  of  each  of  us  should  be  doubled,  and  we  had  to 
pay  twice  as  much  for  everything  that  we  buy,  we  should 


THE    REGULATION    OF    FOREIGN   TRADE         357 

be  no  better  off  than  we  are  now.  But  a  more  serious 
objection  is  this :  no  protective  policy  can  raise  the  prices 
of  all  commodities.  A  duty  can  raise  the  prices  only  of 
articles  that  we  are  in  the  habit  of  importing.  Now,  if  we 
import  anything,  we  must  export  something  to  pay  for  it, 
and  the  export  commodities  must  ordinarily  represent  as 
great  a  volume  of  values  as  the  import  commodities.  In 
the  case  of  the  United  States,  the  volume  of  export  com- 
modities must  be  greater  than  that  of  import  commodities, 
for  the  former  must  pay  interest  on  capital  that  we  have 
borrowed  and  the  cost  of  transporting  our  trade  in  foreign 
ships. 

Now,  the  price  of  a  commodity  that  we  export  must  be 
lower  in  this  country  than  in  the  countries  to  which  it  is 
sent.  The  prices  of  wheat  and  cotton  in  America  must  be 
less  than  the  prices  of  the  same  articles  in  England,  since 
we  are  constantly  exporting  them.  It  is  manifestly  absurd 
to  suppose  that  by  placing  duties  on  wheat  and  cotton  im- 
ported into  the  United  States  we  can  raise  the  price  of 
those  commodities.  Who  would  wish  to  import  them  into 
the  United  States  .-*  The  duty  on  any  export  product  is 
utterly  ineffective. 

We  have  seen  that  restrictions  on  imports  restrict  ex- 
ports also.  They  do  this  by  reducing  the  amount  of 
money  that  the  producer  for  export  receives  for  his  goods. 
An  "all  around"  system  of  duties,  in  spite  of  itself,  im- 
poses a  positive  burden  on  as  large  a  volume  of  industry 
as  that  which  enjoys  special  favors  under  it. 

9.  A  plausible  but  fallacious  argument  for  protection  is 
that  high  zvages  in  America  cannot  be  maintained  in  free 
competition  xvith  low-wage  coimtries. 

Another  argument  for  protective  duties  runs  as  follows : 
The  American  laborer  requires  a  greater  measure  of  the 
necessaries  and  comforts  of  Ufe  than  the  laborers  of  any 
other  country.     His  wages  must  therefore  be  higher.     It 


358  INTRODUCTION   TO   ECONOMICS 

follows  that  American  enterprisers,  having  higher  wages 
to  pay,  are  at  a  disadvantage  as  compared  with  their  for- 
eign competitors.  They  must  therefore  sell  their  goods  at 
higher  prices ;  and  this  they  would  be  unable  to  do  if  the 
foreign  producer  could  bring  his  goods  here  without  pay- 
ment of  duty.  From  this  point  of  view  the  tariff  is  re- 
garded as  the  bulwark  of  the  American  standard  of  living. 
This  argument  can  no  more  bear  analysis  than  the  pre- 
ceding ones.  All  the  export  industries  are  able  to  pay  the 
American  scale  of  wages,  and  yet  undersell  their  foreign 
competitors  on  foreign  soil.  These  industries  are  ham- 
pered, not  aided,  by  the  protective  system.  Apart  from 
the  injury  inflicted  upon  them  by  an  unfavorable  rate  of 
exchange,  these  industries  are  rendered  less  profitable  by 
the  fact  that  many  of  their  expenses  are  increased  by  the 
tariff.  Wheat  and  cotton  growers  are  compelled  to  pay 
higher  prices  for  agricultural  implements,  lumber,  fertil- 
izers, and  other  supplies  because  of  the  protective  duties. 
The  duties  on  iron  and  steel  increase  the  costs  of  railway 
building  and  are  reflected  in  higher  freight  rates,  which 
represent  a  deduction  from  the  net  gains  of  the  producers 
of  the  commodities  that  are  carried  to  the  ports  by  rail. 
If  restrictions  on  imports  reduce  the  amount  of  freight 
carried  to  this  country  from  Europe,  many  ships  are  com- 
pelled to  cross  the  ocean  in  ballast  to  carry  away  our 
exports ;  and  this  means  that  the  exports  have  to  pay 
ocean  freights  covering  the  costs  of  a  return  voyage,  in- 
stead of  a  single  passage  of  the  ocean.  Now,  when  we 
consider  that  in  spite  of  all  these  disadvantages  the  export 
industries  can  retain  the  home  market  and  invade  foreign 
ones,  we  see  clearly  that  a  protective  tariff  is  not  needed 
to  maintain  the  American  rate  of  pay  in  all  industry, 
although  it  may  be  necessary  to  maintain  that  rate  in 
special  industries  —  industries  in  which  our  advantages 
for  production  are  less  telling  than  they  are  in  those  in- 


THE    REGULATION    OF   FOREIGN   TRADE         359 

dustries  that  have  succeeded  in  conquering  a  place  for 
themselves  in  foreign  markets. 

10.  A  policy  ivhicli  draws  labor  from  the  fields  that  are 
of  greater  natural  productiveness  to  fields  of  lower  natural 
productiveness  tends  to  reduce  wages. 

In  order  to  gain  a  clear  view  of  the  relation  of  a  protec- 
tive duty  to  the  rate  of  wages  we  must  return  to  funda- 
mental principles.  In  any  country,  as  was  shown  in  earlier 
chapters,  wages  are  determined  by  the  marginal  produc- 
tivity of  labor.  Wc  will  represent  the  various  opportuni- 
ties for  employment  that  a  country  like  the  United  States 
affords  by  the  symbols  A,  R,  C,  and  D.  A  may  stand  for 
a  group  of  industries  in  which  we  have  exceptional  advan- 
tages over  foreign  countries.  "  B  stands  for  a  group  of  in- 
dustries in  which  our  advantages  are  less,  C  one  in  which 
they  are  still  less,  and  D  the  group  of  industries  in  which 
they  are  least  of  all.  When  our  population  is  so  small  that 
all  our  labor  can  be  engaged  in  the  group  represented  by  A, 
wages  will  be  at  their  maximum.  When  our  population 
increases  so  that  some  of  the  labor  will  have  to  be  set  at 
work  in  group  B,  the  wages  of  all  labor  must  decline  to 
the  level  of  productivity  in  that  group.  We  will  suppose 
that  population  has  increased  up  to  a  point  where  the  op- 
portunities represented  by  A  and  B  are  fairly  wc^ll  manned, 
and  wages  are  determined  by  the  productivity  of  labor  in  B. 

With  wages  thus  determined,  it  is  clear  that  no  employer, 
without  governmental  aid,  can  afford  to  hire  labor  to  ex- 
ploit the  opportunities  represented  by  C  and  D.  This 
would  necessitate  paying  labor  in  C  and  D  as  much  as  it 
produces  in  B,  and  that,  by  hypothesis,  is  more  than  it 
produces  in  C  and  D. 

Now  let  us  suppose  that  a  political  party  is  in  power 
which  holds  the  belief  that  we  should  produce  everything 
that  we  consume  —  that  is,  that  the  opportunities  repre- 
sented by  C  and  D  should  be  exploited  as  well  as  those  rep- 


360  INTRODUCTION   TO   ECONOMICS 

resented  by  A  and  B.  Labor  must  be  drawn  away  from 
A  and  B  and  set  at  work  in  C  and  D.  This  involves  the 
necessity  of  cornpensating  enterprisers  in  some  way  for 
the  disadvantages  under  which  they  will  operate  in  C  and 
D.  Either  wages  must  be  reduced  in  A  and  B,  or  some 
form  of  subsidy  must  be  granted  to  C  and  D. 

The  commodities  that  the  industries  composing  C  and  D 
will  produce  have  been  hitherto,  we  assume,  obtained  from 
abroad  through  exchange  for  commodities  produced  by  A 
and  B.  The  government  now  renders  this  difficult  by 
placing  high  duties  on  the  former  class  of  commodities. 
This  means  that  producers  in  the  groups  A  and  B  — 
both  employers  and  workmen  —  must  pay  higher  prices 
for  what  they  buy.  They  do  not  receive  higher  prices  for 
what  they  sell ;  in  fact,  they  receive  lower  prices,  as  this, 
we  have  seen,  is  the  effect  of  protective  duties  on  export 
industries.  It  appears,  then,  that  part  of  the  disadvantage 
of  producers  in  C  and  D  is  removed  by  reducing  wages 
(estimated  in  purchasing  power)  in  A  and  B. 

After  the  duty  has  gone  into  effect  and  the  prices  of 
commodities  that  can  be  produced  by  C  and  D  have  risen 
sufficiently,  enterprisers  will  be  able  to  hire  labor  at  the 
wages  prevailing  in  A  and  B,  and  establish  industries  in 
C  and  D.  *  So  far  as  the  remaining  laborers  in  A  and  B  buy 
the  products  of  C  and  D,  the  difference  between  the  price 
which  they  pay  for  those  products  and  the  price  that  they 
would  pay  if  they  were  permitted  to  import  those  products 
duty-free  is  a  tax  paid  not  to  the  government,  but  to  the 
producers  in  C  and  D,  to  enable  the  latter  to  remain  in  busi- 
ness. It  is  an  uncompensated  deduction  from  the  natural 
earnings  of  the  laborers  in  A  and  B.  Their  wages  have 
been  reduced ;  nor  are  the  workers  in  C  and  D  paid  as 
much,  estimated  in  purchasing  power,  as  they  would  have 
received  if  they  had  been  allowed  to  remain  in  A  and  B 
under  the  earlier  conditions.     The  net  effect  of  the  impo- 


THE   REGULATION   OF   FOREIGN   TRADE        361 

sition  of  the  duty  has  been  to  saddle  the  self-supporting 
industries,  A  and  B,  with  the  support  of  the  pauper  indus- 
tries, C  and  D.  Yet  the  inventors  of  this  policy  have  the 
effrontery  to  tell  laborers  in  A  and  B  that  this  policy  is  the 
bulwark  of  their  high  rate  of  wages  ! 

The  principles  involved  in  the  illustration  may  be  stated 
in  the  following  general  terms  :  Wages  in  any  country  will 
be  at  the  highest  point  when  all  the  labor  of  that  country 
is  concentrated  in  the  industries  in  which  its  relative  ad- 
vantages over  other  countries  are  greatest.  If  there  are 
no  protective  duties  whatsoever,  employers  will,  as  a  rule, 
seek  out  the  industries  in  which  their  country  has  the 
greatest  relative  advantages.  Protective  duties  enable 
other  industries  to  exist,  but  only  through  taxing  the  more 
productive  industries  for  their  support.  Protection  as  a 
permanent  policy  means  a  slight  'reduction  of  money 
wages,  and  a  greater  reduction  of  wages  estimated  in  pur- 
chasing power.  Instead  of  a  bulwark  of  the  standard  of 
living,  protection  is  a  serious  menace  to  it. 

11.  The  strength  of  the  protectionist  policy  consists  largely 
in  the  fact  that  the  good  effects  of  the  policy  are  more  easily 
perceived  than  the  evil  effects. 

The  arguments  for  protection  that  have  been  discussed 
are  all  manifestly  fallacious.  They  are  not  therefore  to  be 
despised,  since  to  hosts  of  men  they  appear  to  be  absolutely 
irrefutable.  And  this,  as  a  great  French  economist  was 
wont  to  say,  is  because  the  average  man  is  unable  to  weigh 
the  unseen  effects  of  an  economic  policy  against  the  effects 
that  are  seen.  If  we  place  a  high  duty  on  imported  fab- 
rics, the  resultant  high  prices  enable  a  new  industry,  em- 
ploying thousands  of  workmen,  to  be  established.  This  is 
the  effect  that  is  seen,  and  considered  in  itself,  is  wholly 
good.  Every  purchaser  of  the  fabrics  throughout  the  land 
is  compelled  to  pay  higher  prices  for  them  ;  but  this  effect 
is  only  dimly  seen,  if  at  all.      In  itself,  it  is  wholly  evil. 


362  INTRODUCTION   TO    ECONOMICS 

Since  part  of  what  the  new  industry  receives  in  this  way 
from  the  public  goes  to  compensate  that  industry  for  the 
natural  disadvantages  under  which  it  labors,  it  follows  that 
the  aggregate  net  gain  to  the  industry  is  less  than  the  ag- 
gregate net  loss  to  the  public.  Again,  the  national  pro- 
duction of  wealth  is  increased  by  the  amount  that  the  new 
industry  adds,  and  this  effect  of  the  duty  is  one  that  is  seen. 
The  national  production  is  reduced  by  the  amount  that  the 
labor  and  capital  diverted  to  the  new  industry  would  have 
produced  elsewhere  ;  this  effect  is  not  seen.  Yet  the  re- 
duction in  national  production  that  the  duty  entails  is 
greater  than  the  increase  due  to  it,  since  labor  and  capital 
are  diverted  from  the  branches  of  production  enjoying 
greater  natural  advantages  to  branches  enjoying  lesser 
advantages —  a  fact  proved  by  the  very  need  for  a  duty. 

12.  Protection  incirases  the  productiveness  of  labor  and 
capital  if  it  drives  labor  and  capital  ant  of  tJie  less  prodiic- 
tive  into  the  more  productive  fields. 

In  the  foregoing  discussion  the  assumption  has  been 
made  that  when  left  to  themselves  enterprisers  will  seek 
out  the  industries  enjoying  the  greatest  natural  advantages. 
On  this  assumption,  all  that  government  can  do  is  to  force 
industry  into  the  less  productive  fields  —  a  policy  that  can 
result  only  in  reducing  the  national  production. 

Now,  while  the  assumption  is  ordinarily  defensible,  it  is 
not  universally  valid.  Enterprisers  do  not  always  know 
what  fields  offer  the  highest  rewards.  Furthermore,  even 
if  an  enterpriser  suspects  that  a  given  field,  hitherto  unex- 
ploited,  would  offer  rich  returns,  conservatism  may  deter 
him  from  abandoning  a  field  in  which  he  is  already  gaining 
profits  for  a  field  in  which  he  may  gain  larger  profits,  but 
in  which  he  may  also  incur  losses. 

The  men  who  govern  a  nation  may  be  more  far-sighted 
and  more  progressive  than  the  business  men  of  the  same 
nation.     The  former  class  of  men  may  become  convinced 


THE    REGULATION    OF    FOREIGN    TRADE         363 

that  certain  fields  of  production  will  be  profitable  long  be 
fore  the  latter  class  will  venture  into  those  fields.  The 
government,  by  placing  duties  upon  the  products  that  those 
fields  might  yield,  makes  success  a  certainty.  Once  the 
new  industries  are  estabUshed,  the  duties  can  be  removed 
without  destroying  them.  The  industry  of  the  nation  is 
enriched  by  the  addition  of  fields  of  employment  that  are 
as  good  or  better  than  those  already  under  exploitation. 

It  must,  of  course,  be  borne  in  mind  that  this  case  is  a 
rare  one.  It  is  not  often  that  the  statesman  knows  more 
about  business  than  the  body  of  business  men  themselves. 
Where,  however,  the  government  is  manned  by  officials  of  a 
race  intellectually  superior  to  that  of  the  governed,  the 
national  industry  may  be  furthered  in  the  way  described. 

13.  Protection  may  enable  an  indiistiy  of  more  than  nor- 
mal productiveness  to  surmount  initial  obstacles  to  s/iceess. 

Even  when  there  exists  no  superiority  of  foresight  on 
the  part  of  those  who  make  up  the  government,  a  govern- 
ment may  often  succeed  in  diverting  industry  from  fields  in 
which  the  natural  advantages  are  less  to  fields  in  which 
they  are  greater.  The  United  States  has  always  pos- 
sessed special  natural  advantages  for  the  production  of 
iron  and  steel.  What  it  lacked,  in  its  early  period,  was 
training  in  the  art  of  working  metals.  The  enterpriser 
was  unacquainted  with  the  best  processes,  and  he  had  to 
use  labor  that  had  not  acquired  the  skill  and  the  traditions 
necessary  for  efficient  production. 

Now,  the  only  way  to  acquire  an  art  is  to  practice  it. 
We  had  to  make  iron  for  a  long  time  before  we  could  be- 
come adepts  in  the  art.  A  generation  might  have  sufficed 
for  establishing  the  industry  in  a  particular  locality  ;  but 
what  enterpriser  would  have  undertaken  to  produce  at  a 
loss  through  a  generation  in  order  that  some  other  enter- 
priser might  ultimately  conduct  the  business  with  a  profit  .-^ 
Obviously,  the  case  demanded  governmental  aid  ;  and  the 


364  INTRODUCTION   TO    ECONOMICS 

government  did  indeed  come  to  the  aid  of  the  industry, 
through  the  imposition  of  duties  on  imported  iron  and  iron 
wares. 

After  a  reasonable  period  of  time  the  iron  industry  may 
become  well  established  in  a  given  locality,  but  if  the  pro- 
duction of  iron  in  other  localities  promises  ultimate  success, 
the  duties,  it  is  urged,  should  be  continued  for  the  benefit 
of  these  localities.  At  a  time  when  the  first  center  of  the 
industry  is  in  a  position  to  bid  defiance  to  foreign  competi- 
tion, other  centers  are  still  in  extreme  need  of  protection. 

14.  When  an  industry  is  well  established  within  a  country, 
protection  becomes  nnnecessary. 

To-day  our  iron  and  steel  industries  are  highly  developed. 
There  is  excellent  reason  for  believing  that  in  many  sec- 
tions of  the  country  these  industries  could  get  on  very  well 
without  the  protection  they  continue  to  receive.  In  other 
parts  of  the  country  the  industry  may  still  be  in  need  of 
protection.  Now,  is  it  expedient  to  continue  protection  as 
long  as  any  part  of  the  industry  needs  it .''  To  do  so  is  to 
enable  those  parts  that  are  already  able  to  stand  without 
aid  to  levy  upon  the  rest  of  the  industry  of  the  country. 

After  an  industry  has  been  well  established  within  a 
country,  it  migrates  without  great  difficulty  to  other  parts 
of  the  same  country,  if  natural  conditions  warrant.  When 
the  iron  industry  has  been  established  in  Pennsylvania,  it 
readily  migrates  to  Alabama  or  Colorado,  if  natural  condi- 
tions are  as  good  or  better  than  they  are  in  Pennsylvania. 
Processes  that  are  in  use  in  Pennsylvania  can  be  trans- 
ferred without  cost  to  the  other  regions  ;  a  body  of  workers 
can  be  induced,  without  great  difficulty,  to  migrate  with  the 
industry.  There  is  accordingly  far  less  reason  for  giving 
governmental  aid  to  the  newer  centers  than  there  was  for 
giving  it  to  the  original  one.  Accordingly,  we  may  say 
that  it  may  be  advantageous  to  protect  an  industry  until  it 
is  well  estabUshed  within  the  national  domain ;  if  it  is  of  a 


\ 


THE    REGULATION    OF    FOREIGN    TRADE        365 

character  that  fits  it  for  existence  there,  it  will  extend  itself 
to  other  regions  even  if  protection  is  withdrawn. 

15.  In  practice  it  is  difficult  to  detenninc  wJicn  protection 
sJioiild  be  ivithdraivn  from  an  industry. 

When  an  industry  has  become  firmly  established,  fur- 
ther protection  is  inexpedient  and  unjust,  as  it  enables  the 
industry  to  levy  upon  other  industries  that  are  self-sup- 
porting a  tribute  that  it  does  not  need.  Here  a  practical 
difficulty  arises.  How  can  we  determine  just  when  an  indus- 
try has  passed  through  the  period  of  infancy,  and  therefore 
should  be  left  to  shift  for  itself.-*  We  cannot  find  out  from 
those  who  are  engaged  in  the  industry,  since  they  are  natu- 
rally desirous  of  a  continuance  of  public  aid,  even  though 
they  do  not  need  it;  and  those  who  are  not  engaged  in  the 
industr}^  cannot  tell. 

At  the  annual  banquets  of  the  various  manufacturers' 
associations,  the  boast  is  frequently  made  that  we  can  manu- 
facture more  cheaply  than  any  other  nation  on  earth.  But 
if  Congress  proposes  to  reduce  duties,  the  same  men  soberly 
declare  that  our  industries  will  be  ruined  if  this  is  done. 
And  shall  Congress,  in  its  search  for  truth  to  enlighten  it, 
appeal  from  the  manufacturers  sober  to  the  manufacturers 
off  their  guard  and  intoxicated  with  success  .-^  The  fact  is, 
it  is  almost  impossible  for  a  government  to  determine  just 
when  a  protective  duty  can  be  removed.  As  a  result  every 
nation  retains  many  such  duties  long  after  they  have  lost  all 
efficacy  for  doing  anything  but  harm.  Accordingly,  there  is 
good  reason  for  the  view  that  reckless  experimentation  in 
the  establishment  of  new  industries  is  to  be  avoided. 

16.  The  establishment  of  industries  that  will  never  be  able 
to  maintain  themselves  witJiout  protection  should  be  avoided. 

A  stronger  reason  for  cautious  action  lies  in  the  fact 
that  an  industry  established  by  the  aid  of  a  protective  duty 
may  never  develop  sufficiently  to  maintain  itself  without 
governmental  aid.     The  natural  conditions  upon  which  it  is 


366  INTRODUCTION   TO   ECONOMICS 

based  may  be  so  unfavorable,  relatively  to  the  conditions 
in  other  countries,  that  the  industry,  if  established,  will 
be  destined  to  remain  forever  a  burden  upon  the  public  —  a 
pauper  industry.  Let  us  suppose  that  in  a  given  branch  of 
industry  a  commodity  can  be  produced  here  at  a  cost  of 
$1,  while  it  can  be  obtained  from  abroad  for  fifty  cents. 
Without  government  aid,  no  enterpriser  can  afford  to  under- 
take its  production.  Now,  let  us  assume  that  a  statesman, 
eager  to  see  the  United  States  producing  every  possible 
kind  of  goods,  succeeds  in  placing  a  duty  of  fifty  cents  on 
the  imported  article.  The  price  to  consumers  must  then 
rise  to  $1,  a  price  sufficient  to  induce  American  enterprisers 
to  produce  the  goods. 

After  all  the  initial  difficulties,  such  as  training  a  force 
of  men,  establishing  market  conditions,  etc.,  have  been  over- 
come, the  cost  of  producing  the  article  may  fall  to  seventy- 
five  cents,  and  remain  there.  This  is  the  natural  American 
cost  of  it.  If  the  duty  is  removed,  the  foreign  article  will 
again  be  sold  for  fifty  cents.  The  men  who  have  put  their 
capitals  into  the  industry  will  have  to  close  down  their  plants 
and  discharge  their  workmen.  The  buildings  and  machinery 
used  in  the  industry  will  probably  be  worth  almost  nothing 
for  any  other  purpose.  The  skill  acquired  by  the  workmen, 
at  great  cost  of  time,  perhaps,  will  be  equally  worthless. 
The  removal  of  the  duty,  therefore,  involves  the  ruthless 
destruction  of  means  of  wealth  production,  through  no  fault 
of  the  possessors  of  such  means. 

The  question  naturally  arises,  is  it  right  to  call  an  in- 
dustry into  existence  by  governmental  action,  and  later  aban- 
don it  to  the  mercies  of  foreign  competition.''  There  can 
be  but  one  answer:  It  is  not  right.  The  government  did 
wrong  in  calling  into  existence  an  industry  that  would  never 
be  able  to  survive  unaided.  It  does  wrong  again  when  it 
abandons  its  ill-begotten  offspring  to  die  of  starvation.  If, 
however,  the  industry  is  not  abandoned,  it  is  a  perpetual  ex- 


THE    REGULATION   OF   FOREIGN   TRADE        367 

pense  to  the  self-supporting  industries  of  the  country.  A 
human  pauper  dies  in  the  end,  but  a  pauper  industry  may 
live  on  forever. 

17.  Protection  may  serve  a  useful  purpose  in  encouraging 
the  development  of  indiistncs  tJiat  make  no  drain  upon  the 
natural  resources  of  a  country,  and  retarding  the  develop- 
ment of  industries  that  destroy  such  resources. 

A  protective*  tariff  may  sometimes  be  defended  on  the 
ground  that  it  preserves  the  natural  resources  of  a  country 
against  wasteful  exploitation.  If  the  government  does 
not  restrict  international  trade,  we  may,  as  a  rule,  assume 
that  enterprisers  will  seek  out  the  fields  in  which  a  given 
quantity  of  labor  and  capital  will  produce  the  largest 
amount  of  value,  or  the  fields  in  which  our  advantages 
over  foreign  countries  are  greatest.  Let  us  suppose  that 
one  of  those  fields  is  the  growing  of  wheat.  In  most  parts 
of  the  United  States  wheat  culture  represents  a  heavy 
drain  upon  the  fertility  of  the  soil.  Land  devoted  to  con- 
stant wheat  cropping  becomes  almost  exhausted  in  a  gen- 
eration. Accordingly,  when  one  sells  a  bushel  of  wheat, 
he  sells  not  only  the  product  of  his  labor  and  capital,  but 
a  part  of  the  natural  heritage  of  his  country.  But  why 
should  he  care  .-*  After  his  field  is  worn  out,  his  years  will 
probably  be  few.  The  next  generation  may  be  left  to 
repair  the  wastes  of  this  generation. 

Let  us  suppose  that  coal  and  iron  mining  and  the  pro- 
duction of  petroleum  are  other  industries  in  which  we  have 
great  natural  advantages.  Enterprisers,  if  left  to  tliem- 
selves,  would  employ  vast  amounts  of  labor  and  capital  in 
exploiting  these  natural  resources.  Every  year  we  should 
send  away  from  our  country  these  commodities,  represent- 
ing not  merely  the  annual  product  of  our  labor  and  capi- 
tal, but  also  a  part  of  our  irreplaceable  natural  wealth.  In 
a  few  generations  we  should  be,  as  a  nation,  impoverished. 

We  have  seen  that  protection  places  a  burden  upon  the 


368  INTRODUCTION   TO   ECONOMICS 

industries  in  which  we  have,  for  the  present,  great  natural 
advantages,  in  order  to  build  up  industries  in  which  our 
natural  advantages  are  less.  If  the  industries  that  are  nat- 
urally most  productive  are  of  the  kind  that  waste  the  natu- 
ral wealth  of  the  country,  it  is  a  statesman's  proper  policy 
to  impose  upon  them  such  burdens,  and  so  reduce  the 
extent  to  which  they  are  carried  on,  in  favor  of  industries 
which  involve  no  waste  of  resources,  even- though  the  an- 
nual production  of  wealth  is  thereby  diminished  for  a  time. 

The  same  argument,  of  course,  condemns  protection 
under  other  circumstances.  According  to  conservative 
official  estimates,  we  are  using  up,  each  year,  four  times 
as  much  lumber  as  we  are  growing.  The  rising  price 
of  lumber  stimulates  the  activity  of  the  woodsman  to 
greater  and  greater  remorselessness.  Our  mountains  are 
denuded,  and  the  waters,  formerly  held  back  by  the  forest 
covering  and  allowed  to  feed  the  rivers  with  regular  flow, 
now  sweep  down  the  slopes  in  devastating  flood.  Obvi- 
ously, we  should  endeavor  to  stimulate  importation  of  lum- 
ber ;  if  necessary,  we  should  give  a  bounty  on  imports, 
that  the  price  of  lumber  might  be  reduced  and  our  few 
remaining  forests  saved.  But  the  destroyers  of  our  natu- 
ral heritage  demand  protection  in  their  pernicious  pursuit, 
and  we  accord  it  to  them. 

18.  Protection  may  serve  the  purpose  of  encouraging  the 
development  of  industries  that  are  favorable  to  the  health  of 
the  laborer. 

If  extractive  industries,  prosecuted  too  relentlessly,  waste 
the  natural  wealth  of  a  country,  manufacturing  industries, 
prosecuted  in  the  same  way,  waste  its  men.  The  popula- 
tion of  a  manufacturing  center  does  not  usually  compare 
favorably,  in  health  and  vigor,  with  the  population  of  rural 
districts.  Indeed,  it  is  doubtful  whether  an  exclusively 
urban,  manufacturing  population  can  in  the  long  run 
escape  physical  degeneration.     It  might  therefore  be  good 


THE   REGULATION   OF   FOREIGN   TRADE        369 

policy  in  a  country  so  largely  devoted  to  manufactures  as 
England  to  impose  protective  duties  on  imported  agricul- 
tural products,  with  a  view  to  increasing  the  proportion  of 
the  population  employed  upon  the  land.  This  would  in- 
deed burden  the  manufacturing  population  ;  it  would  for 
many  years  reduce  the  product  of  the  national  industry. 
But  in  view  of  the  ultimate  effect  upon  the  character  of 
the  population,  this  policy  might  be  a  good  one  from  the 
point  of  view  of  the  statesman,  who  must  consider  not 
merely  the  prosperity  of  this  year  and  next,  but  also  that 
of  the  remotest  generations. 

There  are  industries  that  in  the  end  destroy  the  health 
of  those  who  are  engaged  in  them.  A  frequently  cited 
case  is  a  certain  branch  of  the  match  industry,  which  con- 
demns its  workers  to  early  disability  or  death.  Yet  in 
many  countries  that  industry  asks  for  protection  and  gets 
it.  Protection  and  encouragement  to  an  industry  that  lit- 
erally devours  one's  fellow-countrymen ! 

19.  A  country  should  be  able  to  provide  itself  ivitJt  means 
for  prvdiicing  commodities  essential  to  the  successful  conduct 
of  a  zvar ;  and  in  many  cases  can  make  such  provision  most 
conveniently  through  protection. 

A  protective  duty  is  defensible  when  it  serves  to  main- 
tain facilities  for  the  production  of  articles  of  national  neces- 
sity, the  supply  of  which  might  be  cut  off  by  war.  War 
vessels  can  be  built  in  Great  Britain  at  far  less  cost  than  in 
the  United  States.  In  time  of  peace  we  should  make  im- 
portant savings  by  having  our  war  vessels  built  in  Great 
Britain.  If  we  were  engaged  in  a  war,  however,  we  could  not 
have  warships  built  in  Great  Britain,  whether  that  country 
were  hostile  or  neutral.  Yet  it  is  precisely  at  such  a  time  that 
we  should  most  need  to  increase  our  navy.  Prudence  there- 
fore demands  that  we  should  provide  ourselves,  in  time  of 
peace,  with  establishments  capable  of  turning  out  warships ; 
and  this  involves  giving  them  work  to  do. 


370  INTRODUCTION   TO   ECONOMICS 

It  is  a  moot  question  whether  the  creation  of  facilities 
for  constructing  merchant  ships  stands  on  the  same  foot- 
ing. In  former  times,  certainly,  a  merchant  fleet  was  an 
indispensable  auxiliary  to  a  fighting  fleet.  The  former  fur- 
nished trained  seamen,  and  many  merchant  vessels  were 
capable  of  speedy  transformation  into  warships.  Modern 
methods  of  construction,  however,  have  widely  differentiated 
between  merchant  ships  and  ships  of  war.  The  former  can- 
not be  fitted  out  in  such  a  way  as  to  enable  them  to  perform 
efficient  service  in  line  of  battle.  The  crews  of  merchant 
ships  are  not  such  satisfactory  material  for  a  naval  force  as 
was  formerly  the  case.  Whether  the  national  defense  re- 
quires the  development  of  a  sea-going  merchant  fleet  or  not 
is  a  question  for  disinterested  experts  to  determine.  If  it 
does,  protection  to  the  American  merchant  marine  is  defens- 
ible, despite  the  cost  that  it  inevitably  entails. 

Many  industries  that  are  not  designed  directly  for  the 
supply  of  articles  of  military  necessity  may  be  placed  in  the 
same  class.  In  order  that  we  may  be  able  to  construct  ships 
and  produce  guns  and  other  instruments  of  war,  we  must 
have  men  who  are  trained  in  metal  working;  and  if  there  is 
no  other  way  of  maintaining  such  a  force  of  workmen,  we 
should  create  and  maintain  an  iron  and  steel  industry 
through  protective  duties.  It  is,  however,  to  be  borne  in 
mind  that  the  maintenance  of  an  industry  large  enough  to 
cover  all  the  demand  for  iron  and  steel  in  time  of  peace  can- 
not be  urged  on  grounds  of  national  defense. 

20.  A  policy  zvJiich  aims  to  make  a  country  completely  in- 
dependent of  the  products  of  other  countries  is  more  likely 
to  create  zveakjtcss  than  strength  in  luar. 

There  are  some  writers  who  extend  the  principle  in- 
volved to  an  unwarranted  extreme.  They  would  have  every 
nation  produce  practically  every  article  that  it  consumes, 
in  order  that  in  time  of  war  there  might  not  be  the  least  in- 
terruption of  supplies.     These  persons  exaggerate  the  de- 


THE   REGULATION   OF   FOREIGN   TRADE        371 

pendcnce  of  one  country  upon  any  other  country  against 
which  it  may  at  some  time  wage  war.  England,  every  one 
knows,  does  not  produce  enpugh  grain  to  feed  her  popula- 
tion. Suppose  that  England  found  herself  at  war  with  the 
United  States.  That  would  indeed  cut  off  American  sup- 
plies of  wheat  and  meat  and  cotton.  But  there  are  many 
other  countries  that  would  be  glad  to  provision  England  at 
the  rates  she  can  afford  to  pay  ;  and  as  for  cotton,  the  Eng- 
lish buyers  would  not  be  a  whit  worse  off  than  the  American 
sellers,  cut  off  from  their  natural  market. 

But  suppose  that  a  coalition  of  all  the  powers  succeeded 
in  destroying  the  British  fleet,  and  in  cutting  off  supplies 
from  every  source.  Would  not  Great  Britain  be  brought 
face  to  face  with  famine  .'*  Certainly.  But  a  coalition  strong 
enough  to  do  this  would  be  strong  enough  to  invade  and  sub- 
jugate Great  Britain,  even  if  that  country  were  absolutely 
self-sufficing.  Furthermore,  any  one  who  knows  anything 
of  the  history  of  coalitions  knows  that  none  will  ever  be 
formed  for  the  purpose  of  bringing  the  British  nation  to 
extinction. 

The  strength  of  a  nation  in  time  of  war  does  not  de- 
pend upon  its  ability  to  produce  everything  that  its  inhabit- 
ants consume.  Rather,  it  depends  upon  the  valor  and  num- 
ber of  its  men,  and  upon  its  general  wealth.  Other  things 
equal,  a  rich  nation  will  overcome  a  poor  one  in  war.  Great 
Britain  is  formidable  because  she  is  rich.  Now,  the  endeavor 
to  make  a  nation  absolutely  self-sufficing  would  end  in  mak- 
ing it  much  poorer  than  it  would  be  if  it  used  its  resources 
in  a  more^economical  way.  If  we  were  to  endeavor  to  raise 
coffee. and  tea,  lest  an  impossible  coalition  of  all  the  world 
might  inflict  upon  us  the  hardships  of  dry  breakfasts,  we 
should  waste  so  much  of  our  energies  in  the  attempt  that  we 
should  be  weakened  in  the  event  of  an  ordinary  war,  in 
which  we  may  any  day  become  involved. 

21.    Duties  imposed  by  ivay  of  rehiliatioti  are  seldom  ad 
vantageoHS  to  the  country  that  imposes  them. 


372  INTRODUCTION   TO   ECONOMICS 

One  further  possible  justification  of  duties  designed  to 
discourage  importation  requires  examination.  Other  coun- 
tries impose  duties  upon  American  products  crossing  their 
borders.  Therefore,  it  is  said,  we  should  impose  import 
duties  on  the  products  of  such  countries,  by  way  of  retali- 
ation.    Let  us  see  whether  this  position  is  tenable. 

If  Germany  places  a  high  duty  on  American  meats,  the 
persons  who  are  injured  most  seriously  are  the  German 
consumers  of  meat.  The  German  producer  of  meat  gains 
an  advantage,  but  this,  under  ordinary  circumstances,  is 
not  commensurate  with  the  loss  to  the  German  consumer. 
The  world  demand  for  American  meat  is  somewhat  reduced, 
and  this  reduces  the  price  of  it  slightly.  A  small  injury, 
therefore,  is  inflicted  upon  the  American  producer  of  meat. 

Now  let  us  suppose  that  in  retaliation  we  levy  extraor- 
dinary duties  on  German  sugar.  The  chief  sufferer  will 
be  the  American  consumer  of  sugar.  The  American  pro- 
ducer will  gain,  but  not  commensurately.  The  world  de- 
mand for  German  sugar  will  be  reduced,  and  this  will 
slightly  reduce  the  price  of  it.  Thus,  in  order  to  punish 
Germany  for  inflicting  a  large  loss  on  German  consumers 
and  a  small  one  on  American  producers,  we  inflict  a  large 
loss  on  American  consumers  and  a  small  one  on  German 
producers. 

But  retaliation  is  war,  and  in  war  the  petty  rules  of  logi- 
cal conduct  are  not  to  be  observed.  The  important  ques- 
tion is  this  :  does  the  policy  of  retaliation  effect  its  purpose  ? 
Will  we  compel  Germany  to  remove  the  obnoxious  duty  .-' 
In  all  probability,  no.  After  the  duty  on  meat  has  been  in 
force  for  some  time,  German  producers  will  increase  their 
facilities  for  producing  that  article.  To  remove  the  duty 
and  expose  to  the  mercies  of  foreign  competition  the  men 
who  had  invested  their  capital  in  good  faith  would  be  a 
policy  as  unjust  as  it  would  be  unpopular.  Similarly, 
American  enterprisers  would  extend  their  facilities  for  pro- 


THE    REGULATION    OF    FOREIGN   TRADE        373 

ducing  sugar,  and  this  would  give  them  an  equitable  claim 
to  a  continuance  of  the  duty.  The  only  result  of  retalia- 
tion is  the  institution  of  permanent  protection.  If  j^er- 
manent  protection  is  desirable,  it  should  be  undertaken 
without  reference  to  the  way  in  which  a  foreign  govern- 
ment conducts  its  own  affairs.  If  it  is  undesirable,  it 
should  not  be  undertaken  at  all. 

22.    Summary. 

In  conclusion  we  may  say  that  protective  duties  may  be 
defensible  (i)  when  they  make  possible  the  introduction  of 
an  industry  which  in  a  reasonable  time  will  compare  favor- 
ably in  productivity  with  industries  that  are  already  self- 
supporting ;  (2)  when  they  preserve  the  natural  resources 
of  a  country  from  wasteful  exploitation  ;  (3)  when  they 
preserve  the  vigor  and  progressiveness  of  the  population 
through  the  maintenance  of  a  just  balance  between  manu- 
facturing and  agriculture,  city  and  country;  and  (4)  when 
they  make  possible  the  maintenance  of  industries  that  add 
materially  to  a  country's  strength  in  time  of  war.  In  any 
case  such  duties  are  a  burden  upon  the  national  wealth,  at 
the  time  when  they  are  instituted,  and  often  for  an  indefi- 
nite time  thereafter,  and  whether  the  benefit  to  be  gained 
is  a  due  compensation  for  the  burdens  involved  is  a  ques- 
tion demanding  in  each  case  careful  consideration.  Duties 
that  are  designed  to  raise  wages  or  to  increase  the  national 
wealth  by  the  introduction  of  industries  in  the  prosecution 
of  which  we  have  no  special  advantages,  are  founded  in  a 
delusion.  They  are  rendered  possible  only  by  the  fact 
that  the  ordinary  mind  does  not  weigh  their  unseen  disad- 
vantages against  their  advantages  patent  to  view. 


CHAPTER  XX 

THE  RELATIONS  OF  GOVERNMENT  TO  THE  ECONOMIC 

ORGANIZATION 

1.  TJie  economic  and  the  legal  systems  of  a  C07i7ttry  are,  in 
a  measiirCy  interdependent. 

The  economic  world  with  the  study  of  which  we  have 
been  engaged  is  a  world  of  free  private  enterprise.  Its 
motive  forces  are  the  acts  of  individuals,  each  seeking  to 
further  his  own  material  interests.  When  such  individuals 
buy  or  sell  material  possessions  or  personal  services,  they 
take  little  thought  of  the  interests  of  society  as  a  whole,  and 
are  little  concerned  with  the  wishes  or  the  will  of  society. 
Yet  the  will  of  society  plays  a  part  in  all  these  transactions, 
for  they  are  shaped  with  tacit  reference  to  the  law.  The 
individual  is  free  to  pursue  his  own  interests  only  within  the 
limits  set  by  the  positive  law  of  the  land. 

If  we  attempt  to  contrast  the  present  economic  state  with 
the  state  that  would  probably  exist  were  there  no  political 
organization  of  society,  we  shall  realize  that  the  will  of 
society,  as  expressed  in  the  acts  of  government  (employ- 
ing the  term  in  its  broadest  sense) ,  has  played  an  exceed- 
ingly important  part  in  economic  evolution.  Without  a  gov- 
ernment strong  enough  to  assure  to  each  man  the  permanent 
possession  of  material  goods  acquired  in  ways  recognized  as 
legitimate,  humanity  could  hardly  have  developed  beyond 
the  hunting,  or  at  any  rate  the  pastoral,  stage.  Without  a 
government  able  to  enforce  contracts  for  the  future  delivery 
of  goods  and  services,  humanity  could  not  have  passed  be- 
yond the  stage  in  which  the  small  artisan  produced  goods, 
on  his  own  account,  for  a  narrow  local  market.  Progress 
in  the  art  of  government  has  been  a  necessary  condition  of 

3?4 


RELATIONS   OF   THE    GOVERNMENT  375 

substantial  economic  progress.  On  the  other  hand,  it  was 
in  large  measure  progress  in  economic  life  that  necessitated 
progress  in  government.  Some  of  the  most  serious  practical 
problems  of  to-day  have  their  origin  in  the  fact  that  political 
evolution  has  not  kept  pace  with  economic.  Our  political 
machinery,  which  developed  under  simpler  economic  condi- 
tions, appears  in  many  instances  incapable  of  maintaining 
justice  under  the  complex  conditions  of  the  present  time. 

2.  TJic  basis  of  modern  economic  policy  is  free  private 
enterprise,  or  laisser-faire. 

A  government  may  limit  its  economic  activities  to  the 
defense  of  private  property  and  the  maintenance  of  the 
obligation  of  contracts.  It  may  assume  the  function  of 
determining  the  conditions  under  which  economic  transac- 
tions are  carried  on,  and  may  even  interfere  in  their  terms. 
It  may  engage  directly  in  the  production  of  goods  and  ser- 
vices. In  the  first  case  the  government  is  said  to  pursue  a 
"  let  alone  "  or  laisser-faire  policy  ;  in  the  second  case,  a 
regulative  or  "paternalistic"  policy;  in  the  third,  a  social- 
istic policy.  In  general,  the  basis  of  modern  economic 
policy  is  laisser-faire.  It  is  true  that  the  regulation  of  an 
industry  by  government  is  a  not  infrequent  phenomenon, 
and  the  direct  participation  by  government  in  the  produc- 
tion of  commodities  and  services  is  not  by  any  means 
unknown.  Nevertheless,  an  overwhelming  majority  of 
modern  economic  transactions  are  carried  on  by  private 
individuals,  subject  to  no  direct  interference  on  the  part  of 
the  government. 

The  question  may  arise  whether  the  existence  of  protec- 
tive tariffs  in  most  of  the  countries  of  the  world  does  not 
make  it  necessary  to  qualify  the  statement  that  laisser-faire 
is  the  basis  of  modern  economic  policy.  In  effect,  the 
United  States  government  prevents  us  from  buying  Eng- 
lish steel,  and  compels  us  to  buy  steel  of  American  manu- 
facture.    Yet  the  method  by  which  it  does  this  does  not 


370  INTRODUCTION   TO   ECONOMICS 

resemble  the  method  of  governmental  regulation,  to  be 
discussed  below.  The  government  imposes  the  condition 
that  every  ton  of  steel  crossing  our  borders  shall  pay  a 
certain  tax.  This  condition  met,  the  steel  becomes  an  arti- 
cle to  be  dealt  in  freely.  In  buying  or  selling  it  men 
consult  only  their  self-interest.  The  imposition  of  the 
duty  creates  a  steel  industry  in  this  country ;  but  the 
method  by  which  this  is  done  is  very  different  from 
the  method  of  governmental  production.  Prices  are  en- 
hanced ;  and  this  leads  individuals,  in  the  pursuit  of  their 
private  interests,  to  engage  in  steel  production.  The  gov- 
ernment, as  it  were,  creates  a  favorable  soil  in  which  free 
enterprise  may  flourish.  We  may,  therefore,  say  that  the 
existence  of  customs  barriers  does  not  render  necessary  a 
qualification  of  the  statement  that  the  economic  policy  of 
modern  governments  is  based  upon  the  principle  of  laisscr- 
faire,  or  free  enterprise. 

3.  TJic  question  whether  the  system  of  free  private  enter- 
^rise  is  conducive  to  the  greatest  human  welfare  demands 
consideration. 

The  system  of  free  enterprise  has  been  at  once  the  sub- 
ject of  extravagant  praise  and  of  savage  criticism.  Some 
writers  attribute  to  it  all  the  progress  in  civilization  that  the 
last  centuries  have  witnessed.  To  these  writers  every  en- 
croachment by  government  upon  the  domain  now  occupied 
by  private  enterprise  is  fraught  with  grave  dangers. 
Other  writers  regard  the  system  as  wholly  corrupt,  and 
hope  to  see  it  replaced  either  by  a  system  under  which  all 
economic  activities  are  minutely  regulated  by  government, 
or  by  one  in  which  the  government  itself  carries  on  all  pro- 
duction of  wealth  in  behalf  of  society  as  a  whole. 

An  exhaustive  treatment  of  these  opposing  views  would 
carry  us  far  beyond  the  scope  of  the  present  work.  We 
may,  however,  consider  briefly  whether,  on  the  whole,  the 
system  of  free  enterprise  meets  the  tests  of  justice  and  of 


RELATIONS   OF   THE   GOVERNMENT  377 

social  expediency.  If  it  dues  this  in  the  main,  there  may 
yet  be  a  distinguishable  field  in  which  individual  enterprise 
should  be  subjected  to  governmental  regulation,  and  yet 
another  field  in  which  the  government  should  participate 
in  the  production  of  wealth.  A  part  of  our  task  must  be 
to  find  the  boundaries  of  the  respective  fields,  if  such  boun- 
daries really  exist. 

4.  From  the  point  of  viciv  of  production  tJic  systeni  of 
free  private  enterprise  has  proved  highly  effective. 

There  can  be  no  question  that  the  productive  power  of 
man  has  been  immensely  increased  in  the  two  or  three 
centuries  in  which  enterprise  has  been  accorded  a  fair 
measure  of  freedom  by  government.  Improvements  in 
methods  of  production  and  the  formation  of  vast  accumu- 
lations of  capital  have  reduced  greatly  the  amount  of  toil 
necessary  for  the  maintenance  of  human  life.  The  amount 
of  commodities  placed  at  the  disposal  of  the  average  man 
has  been  vastly  increased.  Relief  from  toil  and  command 
over  commodities  are  not  tantamount  to  well-being ;  but 
they  serve  at  least  as  a  basis  of  well-being. 

It  would  be  unjustifiable  to  ascribe  the  entire  sum  of 
progress  in  production  to  freedom  of  enterprise.  Many 
other  causes  have  contributed  to  this  progress ;  but  there 
is  no  doubt  that  many  inventions  have  been  made  with  a 
view  to  the  profits  that  might  flow  from  them  ;  and  the 
wide  introduction  of  improved  processes  of  production  has 
been  largely  the  result  of  the  pursuit  of  profit. 

5.  From  the  point  of  view  of  the  distribution  of  xvealtJi  it 
is  not  so  clear  that  the  system  of  free  private  enterprise  has 
resulted  in  unmixed  good. 

One  of  the  patent  results  of  the  system  of  free  enterprise 
has  been  the  formation  of  classes  differing  greatly  in  their 
command  over  wealth.  Inequalities  in  fortune  were  prob- 
ably never  greater  than  they  are  to-day.  It  cannot  be 
said  that  the  poor  are  poorer  than  they  were  in  earlier 


378  INTRODUCTION  TO   ECONOMICS 

stages  of  the  world's  history,  but  it  is  quite  possible  that 
the  wretchedness  of  the  poor  in  our  great  and  wealthy- 
cities  is  greater  than  was  the  case  in  earlier  times.  The 
questions  therefore  naturally  arise  whether  or  not  the 
existing  system  is  just  in  its  distribution  of  wealth,  and 
whether  a  system  more  conducive  to  human  welfare  could 
not  be  devised.  These  questions  involve  so  many  consid- 
erations that  it  is  doubtful  whether  any  human  mind  can 
answer  them  conclusively. 

6.  In  the  apportionmoit  of  profits  among  enterprisers,  a 
measure  of  justice  and  social  expediency  is  discernible. 

We  may  first  inquire  whether  the  existing  system  tends 
toward  justice  from  the  point  of  view  of  those  who  direct 
production,  the  class  of  enterprisers.  Under  competition 
any  enterpriser  may  engage  in  any  branch  of  production, 
and  create  and  sell  wares  to  his  best  advantage.  Any 
enterpriser  may  make  a  calculation  of  costs  and  prices  in 
the  various  branches  of  production.  If  prices  are  high  in 
any  one  field,  relatively  to  cost,  new  enterprisers  press  into 
the  field  ;  the  supply  of  the  commodity  is  increased,  and  its 
price  falls.  It  follows  that  there  is  a  tendency  for  the 
various  classes  of  goods  to  exchange,  one  for  the  other,  in 
proportions  corresponding  with  their  respective  costs  of 
production.  When  this  point  has  been  reached,  justice,  as 
between  different  enterprisers,  has  been  established. 

At  any  given  time,  it  is  true,  some  enterprisers  receive 
greater  rewards,  in  proportion  to  their  outlays,  than  others. 
But  if  competition  is  free,  this  can  happen  only  when  not 
enough  of  one  commodity  is  produced  and  too  much  of  an- 
other. The  high  rewards  given  to  enterprisers  in  the  one 
field  are  an  inducement  to  the  expansion  of  production  in 
that  field ;  the  low  rewards  in  another  field  give  warning 
that  less  of  the  product  of  that  field  is  wanted  by  society. 
The  unequal  treatment  of  enterprisers  is  the  means  by 
which  society  compels  them  to  direct  their  forces  in  such  a 


RELATIONS    OF   THE    GOVERNMENT  379 

way  as  best  to  meet  society's  needs.     The  inequalities  are 
salutary  in  their  effects  ;  when   there  is  no  longer  an  ini 
proper  distribution  of  productive  energies,  they  cease  to 

exist. 

7.  TJiere  is  a  tendency  toward  fairness  in  the  distribution 
of  rezvards  among  the  different  classes  of  workmen  and 
among  capitalists. 

In  a  similar  way,  the  system  of  free  enterprise  tends  to 
estabhsh  justice  as  between  different  classes  of  workmen. 
If  in  any  industry  wages  are  above  the  average,  due  allow- 
ance made  for  relative  agreeableness  and  safety  of  employ- 
ment, labor  tends  to  flow  into  that  industry  from  industries 
in  which  wages  are  below  the  average.  Wages  then  fall 
in  the  former  industry  and  rise  in  the  latter.  The  initial 
inequalities  in  wages  signified  that  there  was  too  much 
labor  in  some  fields,  too  little  in  the  others,  and  the  very 
fact  of  inequalities  of  reward  helped  to  correct  this  condition. 
Justice  is  done  as  soon,  as  social  expediency  permits.  Simi- 
larly, there  is  a  tendency  toward  cciuality  of  rewards  for 
invested  capital. 

8.  The  question  of  justice,  as  betzveen  the  different  eco- 
nomic classes,  admits  of  no  definite  anszoer.  The  existing 
distribution  among  such  classes  may  be  justified,  perhaps, 
on  grounds  of  social  expediency. 

Can  it  be  said  that  the  system  of  free  enterprise  insures 
justice  in  the  relations  of  enterprisers,  capitalists,  and  labor- 
ers with  one  another  1  There  is  no  way  of  weighing  the 
sacrifices  undergone  by  those  who  direct  industry  against 
the  sacrifices  of  those  who  furnish  capital  and  of  those 
who  labor.  We  can,  however,  weigh  the  services  to  so- 
ciety of  the  respective  classes ;  and  we  can  say  that  there 
is  a  tendency  for  rewards  to  proportion  themselves  to  ser- 
vices. This  is  not  equivalent  to  saying  that  the  distribu- 
tion thus  based  on  services  is  just.  P'or  how  came  the 
millionaire  into  a  position  where  he  can  serve,  as  it  were, 


380  INTRODUCTION   TO   ECONOMICS 

by  proxy  —  his  millions  bringing  him  great  rewards,  while 
the  laborer,  serving  in  person,  receives  but  an  insignifi 
cant  return  ?  From  the  point  of  view  of  social  expediency, 
however,  it  seems  more  plausible  that  a  distribution  based 
on  service  is  satisfactory.  Assuring  to  the  capitalist  the 
fruits  of  his  capital  encourages  the  formation  of  new  and 
greater  capitals,  and  these  are  powerful  instruments  for 
increasing  the  social  production  and  hence  for  improving 
the  economic  condition  of  all. 

9.  IVAen  the  parties  to  a  contract  are  unequal  in  skill 
and  strength,  injustice  is  likely  to  result. 

An  economic  system  based  upon  free  contract  will  be 
just  and  socially  expedient  only  when  the  parties  to  each 
contract  stand  on  a  footing  of  substantial  equality.  In  the 
first  place,  the  buyer  must  know  the  properties  of  the 
goods  offered  to  him  as  well  as  the  seller  knows  them ; 
the  laborer  must  know  the  risks  and  inconveniences  attach- 
ing to  a  given  employment  as  well  as  the  employer  knows 
them.  When  an  unscrupulous  horse  dealer  foists  upon  an 
unsuspecting  buyer  an  animal  with  a  hereditary  taint  of 
character  or  defect  of  body,  the  social  welfare  is  in  some 
degree  reduced.  The  seller  receives  wealth,  not  for  his 
services,  but  for  his  rascality ;  the  buyer  parts  with  his 
money,  not  for  utilities,  but  for  "  experience."  If  all  trade 
were  of  this  nature,  as  it  was  among  the  ancient  Greeks, 
we  should,  like  the  ancient  Greeks,  regard  trade  and 
piracy  as  twin  callings. 

10.  Fire  ejiterprise  results  in  approximate  justice  only 
under  competitioji. 

In  the  second  place,  the  buyer  must  be  in  a  position  tq 
deal  with  any  one  of  several  sellers,  each  acting  independ- 
ently of  the  others,  and  the  seller  must  be  able  to  offer 
his  wares  to  any  one  of  several  independent  buyers.  The 
laborer  must  have  the  option  of  selling  his  services  to  any 
one  out  of  a  number  of  independent  employers,  and  the 


RELATIONS    OF    THE    GOVERNMENT  381 

employer  must  have  the  option  of  selecting  from  among  a 
number  of  workmen.  In  other  words,  competition  must 
exist  on  both  sides.  Otherwise  the  seller  or  the  buyer,  the 
laborer  or  the  employer,  is  in  danger  of  being  forced  to 
accept  terms  that  are  manifestly  unfair.  And  this  can 
issue  only  in  the  discouragement  of  production,  and  hence 
in  economic  decay. 

Of  the  two  conditions  stated,  the  latter  —  the  existence 
of  competition — is  the  more  important.  If  competition 
is  active,  the  seller  of  wares  will  point  out  their  good 
qualities,  and  his  competitors  will  point  out  their  bad  ones. 
Even  an  ignorant  buyer  is  thus  in  some  measure  protected 
against  injustice.  When  one  party  to  a  contract  has  no 
competitors  to  fear,  knowledge  on  the  part  of  the  other 
party  is  of  little  avail.  There  is  a  certain  town  which  I 
can  reach  only  by  traveling  over  a  particular  railway  line. 
The  line  is  in  very  bad  shape ;  the  ties  are  rotten  and  the 
rails  are  light ;  the  cars  are  old  and  unsanitary.  Travel 
on  this  line  involves  an  unduly  large  measure  of  danger 
and  discomfort,  and  I  know  it.  Yet  I  must  buy  tickets 
over  the  line,  because  I  have  no  alternative. 

11.  The  govermnent  i/ntst  regulate  the  conditions  and 
terms  of  economic  contracts  ivhcji  its  failure  to  do  so  results 
in  substantial  injustice. 

Now,  if  there  were  merely  sporadic  cases  in  which  con- 
tracts are  made  under  conditions  that  make  possible  a 
wide  departure  from  fairness,  there  would  be  little  need 
for  governmental  intervention.  But  when  there  is  an  ex- 
tensive field  in  which  such  conditions  prevail,  the  need  for 
governmental  intervention  becomes  imperative. 

In  early  times  the  producer  and  the  consumer  were,  as 
a  rule,  neighbors.  The  tailor  and  his  customer  lived  in  the 
same  village.  If  then  the  tailor  worked  under  unsanitary 
conditions,  the  customer  had  a  chance  of  knowing  it.  If 
the  tailor  substituted    inferior   materials,    trusting   to    the 


382  INTRODUCTION   TO   ECONOMICS 

customer's  ignorance,  the  deception  was  likely  to  make  it- 
self known  in  the  wearing  of  the  garments,  and  react  un- 
favorably upon  the  tailor's  business  reputation.  Fair 
dealing,  under  the  circumstances,  was  a  prerequisite  of 
business  success,  and  the  man  who  dealt  dishonestly 
sooner  or  later  reaped  the  due  harvest  of  his  misdeeds. 

To-day  the  man  who  makes  your  clothes  may  live  a 
thousand  miles  away  from  you.  He  may  be  suffering 
from  a  mild  attack  of  smallpox  as  he  works  upon  your 
garments.  You  cannot  see  the  danger  that  lurks  in  them. 
The  milk  that  you  drink  may  come  from  a  dairy  one  hun- 
dred miles  away,  where  no  attempt  is  made  to  prevent  its 
contamination  with  the  germs  of  disease.  The  appearance 
of  the  milk  gives  you  no  warning  of  the  fact.  Patent 
medicine  manufacturers  may  for  years  have  supplied  you 
with  remedies  containing  dangerous  amounts  of  opium  ; 
packing  houses  may  have  furnished  you  with  meat  treated 
with  preservatives  that  undermine  your  health.  Only 
an  expert  can  tell  you  whether  this  is  true  or  not ; 
and  you  can  probably  ill  afford  to  employ  a  corps  of  ex- 
perts to  investigate  the  hidden  qualities  of  the  things  you 
buy. 

The  workman  in  a  large  factory  is  in  a  similar  position 
of  helplessness.  He  cannot  estimate  the  degree  of  danger 
that  unfenced  machinery  represents.  He  cannot  tell 
whether  ventilation  is  adequate,  or  whether  dust  and  nox- 
ious gases  are  properly  disposed  of.  Furthermore,  he  is 
often  unable  to  judge  correctly  as  to  the  number  of  hours 
that  he  can  toil  daily  without  undermining  his  health. 

Not  less  significant  than  the  separation  of  consumer 
from  producer  has  been  the  development  of  combinations 
of  producers.  In  many  fields,  buyers  have  virtually  only 
one  seller  to  deal  with.  In  this  state  of  affairs,  there  is  no 
way  in  which  the  consumer  can  enforce  a  demand  for 
wares  of  good  quality,  if  wares  of  poor  quality  are  more 


RELATIONS   OF   THE   GOVERNMENT  383 

profitable.  The  employee  of  a  monopoly  may  know  that 
unsanitary  conditions  prevail  in  its  shops,  but  he  may  be 
unable  to  find  other  employment.  Furthermore,  the 
prices  of  monopolized  products  are  likely  to  be  unreason- 
ably high,  and  this  means  that  the  monopolist  takes  from 
the  aggregate  income  of  society  a  larger  share  than  his 
services  warrant. 

12.  TJie  government  may  be  called  upon  to  regulate  the 
quality  of  goods  or  of  services. 

Governmental  regulation  of  the  quality  of  commodities 
was  exceedingly  common  in  the  Middle  Ages.  The  weight 
of  the  loaf  of  bread,  the  width  and  quality  of  fabrics,  were 
determined  by  public  authority.  With  the  development  of 
modern  industry  much  of  this  regulation  fell  into  disuse. 
Competition  was  permitted  to  regulate  the  quality  of  com- 
modities as  it  regulated  their  prices.  The  mediaeval  kind  of 
regulation  has,  however,  survived  in  a  few  instances,  where 
the  retention  by  a  country  of  a  valuable  branch  of  trade  for- 
bids individualistic  tampering  with  the  traditional  standards 
of  quality.  The  Persian  government  endeavors  to  suppress 
the  use  of  aniline  dyes  in  the  manufacture  of  rugs,  on  the 
ground  that  the  employment  of  these  dyes  will  ultimately 
destroy  the  foreign  demand  for  Persian  rugs.  The  Japanese 
government  inspects  all  mattings  produced  for  export,  and 
regulates  their  quality. 

The  regulation  of  the  quality  of  goods  in  most  modern 
states  has  for  its  chief  purpose  the  preservation  of  the  public 
health.  The  use  of  certain  ingredients  in  foods  is  forbidden; 
the  use  of  other  ingredients  is  limited  to  certain  fixed  pro- 
portions. An  attempt  is  made  to  insure  the  production  of 
many  classes  of  goods  under  conditions  limiting  the  risk  of 
transmission  of  disease  from  worker  to  consumer.  No  at- 
tempt is  ordinarily  made  to  protect  the  consumer  against 
fraud,  so  long  as  such  fraud  does  not  involve  injury  to 
health. 


384  INTRODUCTION   TO   ECONOMICS 

The  regulation  of  quality  is  carried  farther  in  the  case 
of  certain  goods  and  services  furnished  by  enterprises  en- 
joying a  monopolistic  position.  The  quality  of  gas  to  be 
furnished  to  the  inhabitants  of  a  city  by  a  private  company 
is  commonly  determined  by  public  authority.  The  service 
of  passenger  transportation  by  street  and  steam  railways  is 
often  subject  to  regulation  as  to  quality.  In  these  cases 
regulation  is  often  defended  on  the  ground  that  the  enter- 
prises are  of  a  quasi-public  nature.  But  any  enterprise  which 
obtains  a  monopoly  of  a  branch  of  production  is,  from  an 
economic  point  of  view,  in  the  same  position.  If  a  powerful 
monopoly  controlled  the  iron  and  steel  business  of  the  United 
States,  there  would  be  no  way,  except  governmental  regula- 
tion, of  preventing  the  use  of  ores  rich  in  phosphorus  or 
sulphur  in  the  production  of  iron  destined  to  be  transformed 
into  steel  rails.  This  would  be  a  menace  to  the  safety  of  all 
travelers;  it  would  therefore  be  necessary  in  the  end  for 
government  to  regulate  the  quality  of  steel  produced. 

There  is,  of  course,  a  danger  that  the  government  may 
go  so  far  in  the  regulation  of  quality  as  to  check  legitimate 
improvements.  By  the  aid  of  certain  chemicals,  wheat  flour 
of  a  darker  color  than  consumers  like  may  be  bleached  to 
a  snowy  whiteness.  The  chemicals  are  admittedly  injurious 
to  health  ;  but  they  are  inevitably  driven  off,  either  in  the 
process  of  flour  manufacture  or  in  the  baking  of  bread,  so 
that  hardly  a  trace  of  them  can  be  found  in  the  latter  prod- 
uct. Yet  there  is  some  public  sentiment  in  favor  of  prohibit- 
ing the  bleaching  of  flour.  In  spite  of  the  danger  of  over- 
regulation,  however,  it  must  be  admitted  that  the  principle 
of  regulation  of  quality  is  salutary,  and  that  the  scope  of 
regulation  is  destined  to  extend  itself  in  future. 

13.  A  government  may  regulate  the  prices  of  commodities 
or  services. 

Governmental  regulation  of  the  prices  of  commodities 
and  services  was  also  exceedingly  common  in  the   Middle 


RELATIONS   OF   THE   GOVERNMENT  385 

Ages.  In  modern  times  such  regulation  is  limited  to  the 
field  of  the  so-called  ^uast-pixhlic  enterprises.  The  charges 
of  railway  companies,  of  gas  and  electric  light  companies, 
of  telephone  and  telegraph  companies,  and  even  of  such 
petty  enterprises  as  the  carriage  of  passengers  in  cabs  and 
similar  conveyances,  are  commonly  regulated  by  law. 
Such  regulation  is  not  actually  based  upon  any  economic 
ground,  but  upon  the  legal  ground  that  the  enterprises 
in  question  perform  functions  that  the  state  has  often  per- 
formed, use  the  public  highways,  or  employ  public  powers 
in  obtaining  rights  of  way. 

From  an  economic  point  of  view,  all  the  enterprises 
mentioned  except  the  last  ought  to  be  subject  to  govern- 
mental price  regulation,  because  they  are  monopolies. 
Without  such  regulation,  a  railway  company  might,  if  it 
chose,  levy  such  heavy  charges  upon  the  carriage  of  goods 
away  from  and  into  a  particular  locality  as  to  destroy  the 
business  of  that  locality  and  reduce  the  value  of  property 
situated  there  to  almost  nothing.  If  the  railway  is  the 
only  means  of  transportation  from  a  mining  district,  by 
raising  rates  it  can  reduce  the  profits  of  mine  owners  to 
ni/  and  force  the  closing  of  the  mines.  It  can  then  buy 
up  the  mines  at  a  very  low  figure,  and  operate  them  profit- 
ably on  its  own  account.  True,  this  is  an  extreme  case ; 
yet  it  illustrates  very  well  the  evils  that  an  unregulated 
monopolistic  determination  of  transportation  charges  would 
entail. 

If  a  monopolistic  combination  succeeded  in  gaining  con- 
trol of  the  entire  iron  and  steel  industry,  or  of  the  business 
of  mining  coal,  its  powers  for  extortion  would  be  as  great 
as  those  of  the  railway  in  our  example.  .  What  would  one 
give  rather  than  pass  a  Northern  winter  without  coal  ? 
Not  all  that  one  has,  but  a  good  part  of  it.  If  we  must 
inevitably  see  an  extension  of  monopolistic  enterprise,  as 
many  believe,  it  is  inevitable  that  we  shall  see  an  extension 
of  the  principle  of  governmental  price  regulation. 


386  INTRODUCTION   TO   ECONOMICS 

14.  A  government  may  regulate  the  conditions  under 
which  labor  is  performed. 

So  long  as  economic  organization  remained  simple,  there 
was  comparatively  sligiit  need  for  governmental  regula- 
tion of  the  conditions  under  which  labor  was  performed. 
A  large  proportion  of  those  who  toiled  were  their  own  em- 
ployers, and  these  could  be  counted  upon  to  keep  their 
work  places  in  tolerably  sanitary  condition,  and  to  limit 
their  hours  of  labor  and  the  intensity  of  their  exertion  to 
the  degree  that  considerations  of  health  demanded.  Those 
who  worked  for  wages  enjoyed,  as  a  rule,  conditions  as 
favorable  as  those  of  the  workmen  who  were  in  their 
own  employ.  The  advent  of  the  factory  system  changed 
conditions  materially.  Men,  women,  and  children  were 
congregated  in  great  masses,  under  the  supervision  of 
overseers,  many  of  whom  were  bent  upon  getting  the  maxi- 
mum possible  service  from  the  workers  under  them.  Ma- 
chinery took  a  place  in  the  productive  series,  and  the 
workers  were  forced  to  adapt  themselves  to  the  speed  of 
the  machines.  Competition  between  manufacturers  led  at 
first  to  a  longer  and  longer  working  day,  and  to  greater 
and  greater  intensity  of  effort.  The  worker,  seeking  em- 
ployment, was  in  no  position  to  stipulate  that  the  working 
day  should  be  limited  to  a  reasonable  number  of  hours,  or 
that  the  labor  should  not  be  so  intense  as  to  be  destructive 
of  the  health  of  the  laborer. 

Society,  it  is  clear,  cannot  afford  to  see  the  vitality  of  its 
working  classes  sapped  in  an  effort  to  raise  to  its  maxi- 
mum the  annual  production  of  wealth.  An  individual 
employer  may  profitably  pursue  the  policy  of  hiring  a  set 
of  workmen,  wearing  them  out  in  a  few  years,  and  replac- 
ing them  by  another  set.  From  the  view  point  of  society 
this  policy  is  as  wasteful  as  it  is  cruel.  The  daily  exertion 
of  each  man  should  be  restricted  to  such  measure  that  he 
may  live  a  life  of  normal  length,  enjoying  the  normal  num- 


RELATIONS   OF   THE    GOVERNMENT  387 

ber  of  years  of  health  and  usefulness.  Where  labor  in- 
volves little  strain,  a  man  may  work  ten  hours  or  more  a 
day  without  injury  to  health.  Where  the  strain  is  great, 
eight  hours  may  be  an  unduly  long  workday. 

When  laborers  are  associated  in  strong  unions,  they  may 
be  able,  without  governmental  aid,  to  reduce  the  hours  of 
labor  to  the  measure  that  is  desirable  from  a  social  point 
of  view.  Each  organization  is  composed  of  workers  of  all 
ages,  and  there  is  a  natural  tendency  to  maintain  a  pace 
that  is  not  too  rapid  for  the  older  workers,  hence  not  so 
rapid  as  to  destroy  the  physical  health  of  the  younger  men. 

But  strong  trade  unions  control  only  a  small  part  of 
the  economic  field.  Such  associations  are  especially  weak 
in  industries  employing  large  numbers  of  women  and  chil- 
dren, and  these  are  precisely  the  classes  that  are  most  seri- 
ously injured  by  long  hours  of  work.  Hence  it  has  come 
to  be  generally  recognized  that  the  conditions  under  which 
women  and  children  work  in  factories  ought  not  to  be  left 
to  free  contract.  Hours  of  labor,  for  these  classes,  must  be 
regulated  by  government. 

In  almost  every  modern  state  some  attempt  is  made  to 
regulate  by  law  the  hours  of  labor  of  children  employed  out- 
side of  the  household.  Such  regulation  has  been  carried 
farthest  in  the  states  where  the  system  of  large  scale  produc- 
tion has  long  been  established,  as,  for  example,  in  England. 
In  new  industrial  states,  as  in  Japan,  the  regulation  of  the 
hours  of  child  labor  is  only  in  its  inception. 

The  regulation  of  hours  of  labor  of  women  employed 
under  similar  circumstances  is  also  a  well  estabHshed  policy 
in  the  more  advanced  states.  In  the  United  States  a  serious 
obstacle  to  such  regulation  is  found  in  constitutional  provi- 
sions, originally  designed  to  secure  the  liberty  of  the  indi- 
vidual, but  now  operating  in  such  a  way  as  to  obstruct  his 
chances  of  attaining  freedom  from  industrial  slavery.  The 
regulation  of  hours  of  labor  of  men  has  as  yet  made  com- 


388  INTRODUCTION   TO   ECONOMICS 

paratively  slight  progress;  the  policy  is,  however,  destined 
to  extend  its  scope  in  the  future. 

The  regulation  of  other  conditions  of  employment — ■ 
ventilation,  sanitation,  etc.  —  has  encountered  comparatively 
few  positive  obstacles.  The  field  is,  however,  so  wide,  and 
the  work  of  legislatures  so  slow,  that  hundreds  of  thousands 
of  workmen  are  to-day  employed  under  conditions  involving 
needless  risk  of  mutilation  and  death.  Still  greater  is  the 
number  employed  under  conditions  that  predispose  the 
worker  to  disease.  Progress  in  the  direction  of  regulation 
of  such  conditions  is  steady,  but  dishearteningly  slow. 

15.     TJie  government  may  regulate  rates  of  zvages. 

The  regulation  of  wages  is  a  policy  very  seldom  em- 
ployed in  modern  times.  Doubtless  there  are  many  cases 
in  which  wages  are  far  below  the  level  of  productivity  of 
labor;  and  in  these  cases  it  is  manifest  that  injustice  is  done. 
To  attempt  to  fix  general  wages  by  law,  however,  is  to  en- 
counter grave  difficulties.  If  in  any  industry  wages  were 
fixed  at  a  level  that  seemed  to  the  workers  too  low,  the  lat- 
ter would  feel  justified  in  refusing  to  work.  If  the  level  of 
wages  seemed  to  employers  too  high,  they  would  feel  justi- 
fied in  closing  their  shops.  To  force  the  laborers  to  abide 
by  the  rate  determined  by  government  would  be  to  inaugu- 
rate an  era  of  universal  serfdom.  Men  would  be  compelled 
to  work  on  terms  fixed  by  others,  and  this  is  the  essence  of 
serfdom.  To  force  employers  to  continue  production,  paying 
wages  that  seem  to  them  unduly  high,  would  be  to  confiscate 
property.  In  either  case  it  is  likely  that  economic  progress 
would  be  checked. 

This  does  not  mean  that  it  would  not  be  possible  to  se- 
lect certain  industries,  in  which  the  laborer  is  most  seriously 
exploited,  and  establish  minimum  wages  there.  If  the  rate 
were  too  low,  some  of  the  laborers  could  seek  other  em- 
ployment. If  the  rate  were  too  high,  some  of  the  employ, 
ers  could  remove  their  capital  to  other  industries.     With 


RELATIONS    OF   THE    GOVERNMENT  389 

the  shrinkage  in  the  volume  of  the  industry,  the  price  of 
its  products  would  rise,  and  this  would  enable  the  remaining 
employers  to  pay  the  rate  of  wages  fixed.  True,  some  of 
the  workers  formerly  in  the  industry  would  be  left  without 
employment.  Some  means  would  have  to  be  found  for 
transferring  them  to  other  employments.  However  this 
might  be,  such  regulation,  limited  to  a  few  fields,  would 
encounter  no  insuperable  obstacles,  and  might  result  in 
alleviating  the  distress  of  some  of  the  most  helpless  mem- 
bers of  society.  Some  such  policy  as  this  has  been  inaug- 
urated in  one  of  the  Australian  colonies  —  with  what 
results,  we  shall  better  know  after  the  lapse  of  another 
decade. 

16.  Governmental  rcgnlation  of  the  relations  of  capitalists 
and  enterprisers  is,  in  some  cases,  necessa7y. 

Regulation  of  the  relations  between  enterpriser  and  capi- 
talist, or  between  borrower  and  lender,  tenant  and  land- 
lord, has  largely  fallen  into  disuse.  In  modern  times  the 
man  who  borrows  capital  is  usually  possessed  of  some 
property  and  of  at  least  an  average  degree  of  business  ca- 
pacity. It  may  therefore  be  taken  for  granted  that  he 
will  not  subscribe  to  terms  that  are  not  to  his  advantage. 
If  a  man  is  willing  to  borrow  capital  at  ten  per  cent, 
there  is  good  reason  for  believing  that  the  annual  use  of 
the  capital  is  worth  to  him  at  least  $\o  per  $100.  Accord- 
ingly, there  is  no  reason  why  the  public  authority  should 
interfere  in  the  transaction.  Many  of  our  states  do  indeed 
have  usury  laws,  limiting  the  rate  of  interest  that  may  be 
paid.  But  these  laws  are  easily  evaded,  and  may  be  re- 
garded as  obsolete. 

Where  the  enterpriser  is  a  corporate  body,  as  is  commonly 
the  case  in  large  scale  production,  the  relations  between  those 
shareholders  who  are  actually  in  control  and  those  whose 
voice  in  the  management  is  seldom  heard,  often  require  regu- 
lation.    The  small  investor  in  a  large  corporation  is  often 


390 


INTRODUCTION   TO   ECONOMICS 


at  the  mercy  of  a  group  of  large  investors,  who  manage 
the  property  in  their  own  interests,  not  in  those  of  the 
entire  body  of  stockholders.  Something  akin  to  the  con- 
fiscation of  property  takes  place  when  the  men  in  control 
of  a  corporation  undertake  a  "  shaking  out "  of  the  "  Httle 
men."  There  is  probably  no  class  in  the  United  States 
to-day  more  in  need  of  governmental  regulation  than 
these  "  little  men."  In  the  end,  doubtless,  regulation 
will  come,  and  the  small  investor  in  a  corporation's  stock 
will  know  whether  he  is  buying  property  or  shadowy  hopes, 
and  whether  or  not  he  will  be  permitted  to  keep  what  he 
has  purchased. 

Relations  between  landlord  and  tenant  assume  the  guise 
of  a  social  problem  wherever  the  ownership  of  land  has 
become  divorced  from  its  cultivation.  Where  a  small 
number  of  large  landholders  deal  with  a  vast  number  of 
small  tenants  there  is  often  opportunity  for  the  oppression 
of  the  latter.  The  tenant  who  brings  a  tract  of  land  into 
an  excellent  state  of  cultivation  should  not  be  evicted  by 
the  landownerwithout  fair  compensation.  Justice  demands 
that  he  should  be  permitted  to  retain  his  occupancy  of  the 
land  until  he  has  reaped  the  fruits  of  his  labor.  Upon  the 
renewal  of  his  lease  he  should  not  be  compelled  to  pay  an 
additional  sum  for  the  use  of  the  productive  powers  that  he 
has  himself  created.  A  wise  landlord,  it  is  true,  will  not  deal 
unjustly  with  tenants  who  increase  the  productive  power 
of  his  land  ;  but  not  all  landlords  are  wise.  The  tenant 
may,  in  some  measure,  safeguard  his  interests  by  the  terms 
of  the  contract  under  which  he  enters  upon  his  tenancy  ; 
but  not  all  the  conditions  that  may  arise  during  a  term 
of  tenancy  can  be  covered  by  a  formal  contract.  Accord- 
ingly, the  state,  under  the  conditions  assumed,  may  be 
called  upon  to  regulate  the  relations  of  landlord  and  tenant 
in  such  a  way  that  the  latter  may  proceed  confidently  with 
the  improvement  of  the  land,  knowing  that  he  cannot  be  de- 


RELATIONS    OF    THE    GOVERNMENT  391 

prived  of  his  due  reward.  No  general  problem  of  this  na^ 
ture  has  arisen  in  the  United  States.  This  is  due  to  the  fact 
that  it  is  easy  for  any  energetic  cultivator  to  acquire  land  of 
his  own.  It  is  quite  conceivable  that  at  some  future  time, 
when  the  rising  price  of  land  and  the  resultant  concentra- 
tion of  holdings  have  given  rise  to  a  permanent  class  of 
tenant  cultivators,  the  regulation  of  the  relations  of  land- 
lord and  tenant  will  assume  great  importance. 

17.  Governmental  irgulation  does  not  change  the  funda- 
mental characteristics  of  the  existing  economic  system. 

The  foregoing  survey  is  sufficient  indication  of  the 
fact  that  the  regulative  activities  of  government  already 
cover  a  wide  field,  and  we  have  excellent  reason  for  be- 
lieving that  the  scope  of  such  activities  will  in  the  future 
be  greatly  extended.  In  so  far,  we  are  drifting  away  from 
an  economic  system  based  upon  free  private  enterprise.  It 
cannot  be  said,  however,  that  the  essential  nature  of  the 
existing  economic  system  is  thereby  altered.  That  system 
is  based  upon  private  initiative ;  and  though  the  govern- 
ment may  restrict  the  field  in  which  private  initiative  finds 
exercise,  it  does  not  bind  initiative  itself.  The  government 
may  prohibit  the  production  of  certain  articles.  In  so  doing 
it  warns  private  enterprise  away  from  a  limited  field ;  but 
there  remain  other  fields  open.  The  government  may  fix 
the  price  at  which  a  certain  article  may  be  sold,  but  this  price 
must  be  left  high  enough  to  tempt  private  enterprise  into  the 
field ;  otherwise  the  article  will  not  be  produced.  The 
government  may  prohibit  the  employment  of  certain  classes 
of  persons,  and  restrict  the  hours  of  labor  of  other  classes. 
Private  enterprise  is  still  called  upon  to  furnish  employment, 
and  the  conditions  may  not  be  made  so  onerous  as  to  exclude 
the  possibihty  of  liberal  profits.  A  system  of  regulated 
enterprise  is  none  the  less  a  system  of  private  enterprise. 
A  range  of  choice  and  an  opportunity  for  gain  are  left  open 
to  the  enterpriser,  and   if  enterprise  is  really  active,  it  is 


392 


INTRODUCTION  TO   ECONOMICS 


forever  creating  new  opportunities  beyond  the  reach  ot 
regulation. 

It  may  appear  that  while  the  existing  system  of  eco- 
nomic organization  is  in  no  danger  of  subversion  through 
the  extension  of  governmental  regulation,  it  is  in  danger  of 
being  supplanted  by  a  system  of  governmental  enterprise, 
or  a  socialistic  state.  We  have  already  many  examples 
of  direct  production  of  commodities  and  services  by  the 
state;  and  we  may  predict  an  increasing  number  of  such 
enterprises  for  the  future.  Must  we  therefore  believe  that 
a  time  will  come  when  the  state  will  enter  all  branches  of 
industry,  and  organize  the  whole  working  population  as  a 
civil  service  corps .''  We  shall  get  some  light  upon  this 
question  from  a  study  of  the  reasons  that  have  led  to  the 
direct  participation  of  government  in  industry.  From  such 
a  study  we  may  draw  inferences  as  to  whether  or  not  the 
same  reasons  will  lead  to  an  indefinite  extension  of  the 
principle  of  governmental  enterprise. 

18.  A  government  may  take  over  an  itidiistry  for  the  pur- 
pose of  securing  a  revenue  from  the  profits  of  the  industry. 

In  some  instances,  the  production  of  a  commodity  or  a 
service  is  undertaken  by  government  solely  with  a  view  to 
securing  a  revenue.  This  is  the  case  with  the  tobacco 
monopoly  of  France  and  of  some  other  countries,  the  salt 
monopoly  in  British  India,  and  a  few  other  public  monop- 
olies. The  profits  of  the  business  take  the  place  of  reve- 
nues that  would  otherwise  be  raised  by  taxation.  The 
government  of  France,  instead  of  operating  a  tobacco 
monopoly,  might  levy  duties  on  the  manufacture  and  sale 
of  tobacco.  If  the  policy  of  a  government  monopoly  is 
resorted  to,  the  product  is  sold  to  the  public  at  a  price 
exceeding  cost  of  production.  This  excess  of  price  repre- 
sents the  net  revenue.  Let  us  say  that  in  a  given  country 
the  price  will  be  so  high  as  to  yield  a  net  revenue  of 
^20,000,000.     Now,   the  government   might   place   a    tax 


RELATIONS    OF    THE    GOVERNMENT 


393 


yielding  $20,000,000  on  the  private  manufacture  of  the 
article.  The  manufacturers  would  add  the  tax  to  the  price 
paid  by  the  consumers.  In  cither  case  the  government 
would  get  the  same  revenue.  In  cither  case  the  consumer 
would  bear  the  burden.  Which  is  the  better  policy,  then,  a 
government  monopoly  or  a  tax  yielding  the  same  revenue  ? 

Under  private  enterprise  the  price  of  tobacco  will  be 
determined  by  cost  of  production  plus  the  tax.  Say  that 
the  aggregate  cost  of  production  of  all  the  tobacco  used 
in  the  country  is  $40,000,000.  Add  to  this  a  tax  of 
$20,000,000,  and  the  consumers  will  have  to  pay  about 
$60,000,000  for  it.  Under  government  enterprise,  what 
will  it  cost  to  produce  the  tobacco  .''  The  government  can 
borrow  capital  at  a  lower  rate  than  private  enterprisers  ;  it 
is  likely  to  pay  higher  wages.  Laborers  in  the  employ  of 
the  government  are  not  likely  to  work  so  hard  as  those  in 
the  employ  of  private  persons.  Let  us  therefore  say 
that  the  production  of  tobacco  costs  the  government 
$50,000,000.  To  this  add  $20,000,000  profit  for  the 
public  revenues,  and  the  consumers  will  have  to  pay 
$70,000,000  for  what  they  would  have  paid  $60,000,000 
under  private  enterprise,  subject  to  excise  taxation. 

From  this  example  the  following  principles  may  be 
drawn  :  When  the  cost  of  production  in  governmental 
shops  is  greater  than  the  cost  in  private  shops,  with  a 
given  burden  upon  the  consumer  a  larger  revenue  can  be 
obtained  by  the  government  through  taxation  than  through 
governmental  enterprise.  The  cost  of  production  is  or- 
dinarily greater  in  governmental  shops  than  in  private 
shops.  There  is  accordingly  little  reason  for  an  expansion 
of  governmental  enterprise  for  the  sake  of  obtaining 
revenue. 

19.  T//r  govei'nmcnt  may  assume  conirol  of  an  industry 
for  the  purpose  of  regulating  tJie  quality  or  the  price  of  the 
product. 


394  INTRODUCTION    TO    ECONOMICS 

The  assumption  by  governments  of  the  sole  right  to  coin 
money  is  an  illustration  of  an  industry  undertaken  by  gov- 
ernment for  the  purpose  of  regulating  the  quality  of  the 
product.  Imagine  the  inconvenience  of  a  currency  com- 
posed of  coins  struck  by  all  the  private  companies  that 
mine  gold  or  silver  !  Some  would  be  light  weight,  some 
heavy  ;  some  would  have  much  alloy,  some  little.  Obvi- 
ously, absolute  uniformity  and  absolute  conformity  to  well- 
known  standards  are  essentials  of  a  currency  employed  in 
a  modern  state.  And  such  uniformity  and  integrity  of 
quality  can  be  secured  only  when  the  coins  are  issued  by 
an  organ  of  society  which  regards  the  interests  of  society 
as  paramount.  Doubtless  it  costs  more  to  coin  money  in 
government  establishments  than  it  would  cost  in  private 
establishments.  But  this  waste  is  insignificant  as  com- 
pared with  the  gains  from  a  currency  of  unquestioned 
soundness. 

A  similar  reason  has  led  to  the  nationalization  of  the 
railway  in  many  countries,  and  to  a  popular  demand  for 
nationalization  in  other  countries.  If  we  could  be  sure  that 
private  railways  would  furnish  good  service,  at  equal  terms 
to  all,  and  at  reasonable  charges,  we  should  never  regard 
government  ownership  of  railways  as  desirable.  But  of 
this  we  cannot  be  sure.  We  Have  tried  regulation,  and  are 
still  trying  it ;  and  it  may  be  that  we  shall  succeed  in  our 
endeavors  to  secure  impartial  and  reasonable  treatment  of 
shippers  and  travelers.  If  we  cannot  do  this,  we  shall  in 
the  end  make  up  our  minds  that  the  railway  is  to  other 
business  enterprises  what  the  coinage  is  to  other  com- 
modities —  an  essential  link  in  almost  every  business  trans- 
action —  and  that  its  social  aspects  are  of  paramount 
importance. 

A  similar  argument  applies  to  the  so-called  municipal 
monopolies  —  street  railway  transportation,  the  furnishing 
of  water  and  light,  and  the  telephone  service.     If  it  is  im- 


RELATIONS    OF   THE    GOVERNMENT  395 

possible  to  regulate  the  quality  and  the  price  of  service 
under  private  management,  public  management  becomes 
necessary.  It  is,  however,  to  be  borne  in  mind  that  such 
regulation  is  impossible  only  when  the  people  are  unable 
to  select  able  and  honest  officials  ;  and  when  such  is  the 
incapacity  of  the  people,  government  enterprises  stand 
little  chance  of  being  managed  efficiently  and  honestly. 

20.  W/u-re  the  utilities  created  by  an  industry  are  not 
appropriable,  government  operation  beeomes  a  necessity. 

In  the  foregoing  instances  there  is  no  inherent  necessity 
for  public  operation  of  industry.  In  the  first  case  this 
policy  is  adopted  in  lieu  of  a  policy  of  taxation ;  in  the 
other  cases,  in  lieu  of  a  policy  of  regulati(5n.  We  come 
now  to  consider  cases  in  which  government  enterprise  is 
necessary,  because  it  is  the  only  means  of  securing  certain 
important  utilities  for  society. 

In  some  branches  of  industry,  practically  all  the  utilities 
created  embody  themselves  in  a  concrete  form,  so  that  the 
producer  is  able  to  recoup  himself  for  his  costs  of  production 
through  sale  of  the  utilities  to  those  who  are  to  enjoy 
them.  The  utilities  created  by  a  shoe  manufacturer  are 
embodied  in  the  shoes  ;  and  the  manufacturer  can  obtain 
from  the  user  of  shoes  a  price  that  will  compensate  him 
for  his  expenses.  If  the  consumer  will  not  pay  enough 
to  cover  costs,  the  shoes  ought  not  to  be  made,  for  there 
are  no  utilities  arising  from  their  making  that  the  con- 
sumer cannot  appraise. 

We  may  contrast  with  the  utilities  furnished  by  such 
an  industry  the  utilities  furnished  by  a  lighthouse.  These 
are  scattered  far  and  wide  over  the  waters  that  are  rendered 
safe  by  the  light.  They  benefit  every  shipowner  whose 
vessel  sails  in  these  waters  ;  every  passenger  for  whom 
the  danger  of  death  at  sea  is  thereby  reduced ;  every 
shipper  who  pays  lower  freights  because  of  the  smaller 
chance  of  the  foundering  of  ships.     In  a  year's  time  the 


396  INTRODUCTION   TO    ECONOMICS 

utilities  contributed  by  the  lighthouse  may  far  exceed  its 
cost  of  maintenance.  But  if  you  or  I  were  to  erect  a 
lighthouse,  how  would  we  collect  pay  for  these  utilities 
from  the  beneficiaries  ?  Clearly,  this  is  no  field  for  private 
enterprise,  and  yet  it  is  a  field  in  which  labor  and  capital 
may  produce  greater  utilities  than  elsewhere.  The  gov- 
ernment, as  the  representativ^e  of  society,  can  alone  afford 
to  exploit  this  field. 

Again,  an  industry  may  produce  some  utilities  that  are 
concrete  and  appropriable,  and  some  that  are  elusive,  flow- 
ing freely  to  persons  who  cannot  be  made  to  pay  for  them. 
In  a  very  slight  degree  this  is  true  of  all  industries ;  but 
we  are  concerned  only  with  cases  in  which  this  differentia- 
tion of  utilities  is  well  marked.  We  may  take  as  an 
example  common  school  education.  The  children  who 
receive  instruction  are  the  immediate  beneficiaries  ;  they, 
or  their  parents,  could  be  made  to  pay  something  for  it. 
But  all  of  us  who  wish  a  government  of  officials  selected 
by  intelligent  voters ;  all  of  us  who  prefer  intelligent  and 
efficient  employees  to  ignorant  ones ;  all  of  us  who  wish  to 
enjoy  the  products  of  a  rich  and  varied  national  produc- 
tion, —  are  the  indirect  beneficiaries.  A  great  part  of  the 
total  benefit  from  educating  a  child  is  reaped  by  persons  not 
connected  with  him  by  ties  of  blood  or  personal  interest. 

Now,  if  the  benefit  to  the  child  is  so  great,  and  so  clearly 
appreciated  by  him  or  by  his  guardians,  that  the  entire  ex- 
pense of  education  can  be  met  by  tuition,  we  who  are  also 
beneficiaries  may  take  our  gains  gratis.  But  if  this  is 
not  the  case  —  and,  as  a  rule,  it  is  not  —  we  should  be 
very  shortsighted  if  we  refused  to  contribute  our  share  to 
the  expenses  of  his  education.  From  a  social  point  of  view 
the  benefits  of  popular  education  far  outweigh  the  ex- 
penses of  it,  the  expenses  cannot  in  each  case  be  assessed 
upon  the  beneficiaries;  therefore  the  production  of  the 
Utilities  in  question  must  be  undertaken  by  government. 


RELATIONS    OF    THE    GOVERNMENT-  397 

Another  case  may  now  be  cited.  Near  one  of  our  large 
cities  there  is  an  island  which  is  capable  of  providing 
building  lots  for  a  large  population.  Until  recently  com- 
paratively few  persons  could  make  the  island  their  home, 
on  account  of  the  uncertainty  and  inconvenience  of  passage 
to  the  city.  A  ferry  service  existed,  but  the  boats  were 
small,  old,  and  slow.  The  owners  of  the  ferry  line  could 
not  furnish  better  service,  however,  because  the  increase  in 
fares  would  not  cover  the  increase  in  expense. 

The  introduction  of  an  efficient  ferry  service  would 
have  greatly  increased  the  value  of  land  on  the  island ;  it 
would  have  furnished  an  outlet  to  some  of  the  surplus  popu- 
lation of  the  city,  and  diminished  the  evils  of  overcrowding 
in  tenements.  These  utilities  might  very  well  have  been  of 
sufficient  annual  value  to  offset  the  increased  cost  of  service. 
But  the  private  ferry  company  could  collect  no  charge  for 
such  utilities  ;  therefore  it  could  not  make  the  improvement. 
The  city,  on  the  other  hand,  could  very  well  afford  to  estab- 
lish a  satisfactory  service  to  the  island,  since  the  city  as  a 
whole  would  get  most  of  these  elusive  benefits,  in  addition 
to  the  fares  it  would  collect  from  passengers. 

It  is  obvious  that  the  same  principle  may  be  extended  to 
a  great  many  enterprises  —  street  railways,  steam  railways, 
etc.  At  any  given  time  most  of  the  utilities  produced  by 
such  an  enterprise  as  a  street  railway  system  may  be  of  such 
a  character  that  a  price  can  be  charged  for  them.  As  the 
city  grows  in  size  and  questions  of  transportation  assume 
greater  and  greater  importance,  the  utilities  that  are  not 
appropriable  increase  in  number  and  in  value.  In  the  end, 
these  utilities  may  come  to  be  of  such  significance  that  the 
transit  system  ought  to  be  managed  chiefly  with  reference 
to  them.  In  such  case  public  ownership  ought  to  take  the 
place  of  private  ownership. 

Now,  as  population  increases,  the  industries  producing 
non-appropriable  utilities,  along  with  those  that  are  appro- 


398  ■    INTRODUCTION   TO    ECONOMICS 

priable,  become  more  numerous  —  or,  more  exactly,  the 
non-appropriable  element  in  utility  production  becomes 
more  important,  relatively  to  the  appropriable  element. 
Accordingly,  an  expansion  of  public  enterprise,  in  this  di- 
rection, seems  probable. 

21.  When  private  enterprise  is  too  zvcak  to  enter  npon  a 
productive  field,  government  enterprise  is  sometimes  neces- 
sary. 

One  further  case  in  which  public  enterprise  may  enter 
the  field  of  production  may  here  be  touched  upon.  Some- 
times private  enterprise  is  not  sufficiently  daring  or  skillful 
to  enter  upon  the  supplying  of  utilities  even  when  there  is 
no  obstacle  in  the  way  of  charging  a  price  for  them.  The 
government,  if  under  the  control  of  able  administrators,  may 
then  increase  the  social  welfare  by  undertaking  production 
directly.  When  a  country,  long  habituated  to  one  mode  of 
economic  life,  is  suddenly  compelled  to  adapt  itself  to  new 
conditions,  this  superiority  of  public  to  private  enterprise 
may  manifest  itself.  In  the  last  half  century  many  enter- 
prises have  been  undertaken  by  the  Japanese  government, 
in  fields  ordinarily  left  to  private  business.  As  a  class  of 
enterprisers  developed,  the  control  of  such  business  has 
been  gradually  transferred  to  them.  When,  on  the  other 
hand,  initiative  dies  out  in  a  people,  owing  to  the  weeding 
out  of  the,  more  intelligent  and  enterprising  elements  in 
the  population,  the  government  may  gradually  assume  con- 
trol of  production  and  trade.  Something  of  this  nature  oc- 
curred in  the  later  years  of  the  Roman  Empire  and  in  the 
declining  period  of  Venetian  history. 

So  long  as  there  remains  in  society  a  large  class  of  per- 
sons possessing  enterprise  and  ingenuity,  there  is  little 
reason  for  believing  that  the  extension  of  the  field  of  public 
enterprise  will  really  narrow  the  field  of  private  enterprise. 
For  the  boundaries  of  the  latter  can  be  extended  indefinitely 
outward,  so  long  as  men  have  wants  that  remain  unsatisfied. 


RELATIONS    OF   THE    GOVERNMENT  399 

Public  enterprise  will  supplant  private  enterprise  only 
when  the  latter  has  become  impotent  to  direct  the  supply- 
ing of  the  needs  of  society. 

22.    Summary. 

The  basis  of  the  modern  industrial  system  is  free  private 
enterprise ;  such  apparent  violation  of  the  principle  as  a 
protective  tariff  represents  does  not  alter  its  fundamental 
truth. 

The  system  of  private  enterprise  has  proven  highly  ef- 
fective in  the  field  of  production ;  in  the  field  of  distribution 
it  is  impossible  to  give  an  unqualified  opinion  as  to  the 
justice  and  expediency  of  the  system.  Unregulated  private 
enterprise  gives  rise  to  serious  evils  which  demand  govern- 
mental intervention. 

In  general,  wherever  gross  inequality  appears  in  the 
bargaining  power  of  parties  to  contracts,  governmental 
regulation  is  necessary.  The  government  may  be  called 
upon  to  regulate (i)  the  quality  of  commodities  and  services; 
(2)  the  price  of  commodities  and  services;  (3)  the  condi- 
tions of  labor;  (4)  the  wages  of  labor;  (5)  the  relations 
between  capitalist  and  enterpriser. 

Governments  often  participate  directly  in  industry. 
The  purpose  of  public  enterprise  may  be  merely  the  secur- 
ing of  a  revenue.  This  end  may  usually  be  better  attained 
through  taxation  of  private  industry ;  hence  extension 
of  governmental  enterprise  to  this  end  is  improbable. 
The  government  may  take  over  an  industry  in  order  to  regu- 
late effectively  the  quality  or  the  price  of  the  product  of 
the  industry.  Public  enterprise  having  this  object  is  likely 
to  become  more  common  with  the  development  of  society. 
The  government  may  take  over  industries,  the  utility-pro- 
duct of  which  is  not  readily  appropriable.  Public  enter- 
prise of  this  nature  is  also  likely  to  increase  in  importance. 
The  government  may  found  industries  when  private  enter- 
prise is  lacking  in  efficiency. 


INDEX 


Agriculture,  combinations  in,  139-40- 
American  Federation  of  Labor,  181 ;  183. 
Apprenticeship,     regulations     of     trade 

unions,  176-78. 
Arbitration,  185-87  ;  compulsory,  187-88. 

Bank,  ch.  XVI ;  functions  of,  281-87. 
Bank  credit,  as  a  substitute  for  money, 

300. 
Bank  deposits,  origin  of,  291-93. 
Bank  loans,  character  of,  290. 
Bank  notes,  297-300. 
Bank  reserve,  294-95. 
Bank,  savings,  317-19. 
Banking,  safety  of,  296-97. 
Barter,  in  international  trade,  337-38. 
Bills  of  exchange,  284  ;  338  et  seq.  ;  effect 

of  changes  in  price  of,  344-45  ;  353. 
Bimetallism,  259;  262;  272-74. 
Bonds,  306. 
Boycott,  182-84. 
Broker,  321-22 ;  310. 
Building  and  loan  association,  319-20. 
Buyers,  marginal,  40-41. 
By-products,  129-30. 


Capital,  ch.  XII  ;  artificial  and  natural, 
197-99;  ^s  affected  by  increase  in 
labor,  100-01 ;  definition  of,  193-94 ; 
increase  of,  effect  on  wages,  204-05 ; 
measured  by  cost  of  replacement,  228- 
29;  natural,  as  affected  by  increase  of 
artificial  capital,  207-08;  permanence 
of,  194-96;  productive  and  acquisi- 
tive, 196-97 ;  productivity  of,  200  ei 
seq. ;  productivity  of,  as  affected  by 
risk,  211-13;  tendency  of,  toward 
equalized  productivity,  209-11 ;  trans- 
fer of,  280  et  seq.  ;  303  et  seq. 

Capital  goods,  192-93;  productivity  of, 
199  et  seq.;  revaluation  of,  208. 

Capitalization,, 228-31 ;  of  profits,  248- 
49. 

Charging  what  the  traffic  will  bear,  74- 

Checks,  287-88. 

400 


Child  labor,  117;  387. 

Classes,  economic,  16-18;  377-78- 

Clearing  house,  293-94. 

Closed  shop,  175-76. 

Coinage,  394  ;  free,  258-60. 

Collective  bargaining,  173-74 ;  184-85. 

Combinations,  ch.  IX;  50-51;  in  agri- 
culture, 139-40;  in  railway  business, 
138  ;  partial,  140-41  ;  relation  to 
concentration,  137;  temporary,  139- 
40. 

Competition,  14-16  ;  as  affecting  mo- 
nopoly price,  65-66;  between  laborers 
in  different  employments,  163-64; 
potential,  66;  regional,  87-89;  relation 
to  enterprise,  237-38;  relation  to  prob- 
lem of  justice  in  distribution,  380-81; 
restrictions  upon,  16. 

Concentration,  ch.  VIII ;  as  affected  by 
concentration  of  wealth,  124-25;  as 
affected  by  improvements  in  trans- 
portation, 123-24;  as  affected  by  law 
of  diminishing  returns,  134-35;  as 
affected  by  railway  discriminations, 
132;  dependent  upon  corporate  form 
of  organization,  125-26;  in  agriculture, 
122-23;  of  wealth,  124-25;  relation  to 
combination,  137;  statistics  of,  121-22. 

Conciliation,  187. 

Consolidation,  141 ;   144*/^^^.;  149. 

Consumer's  goods,  4 ;  192-93. 

Consumption,  8. 

Contract  labor,  241-43. 

Coolie  labor,  241-43. 

Cooperation,  9. 

Corporation,  125-26;  390. 

Cost  of  production,  ch.  V;  238;  as  de- 
termined by  price,  89-90  ;  as  determin- 
ing price,  48-49  ;  59;  89-90;  marginal, 
relation  to  value,  55-59;  relation  to 
international  trade,  334-37. 

Cost  of  replacement,  as  a   measure   of 

capital,  228-29. 
Credit,  282-83;  effect  on  value  of  money, 

266-67. 
Credit  instruments,  283-84. 


INDEX 


401 


Debt,  public,  origin  of,  304-05. 

Demand,  definition  of,  39;  elasticity  of, 
in  relation  to  monopoly  price,  68-69. 

Demand  a  supply,  39  et  seq.;  in  relation 
to  price  of  exchange,  339  et  seq . 

Deposits,  bank,  origin  of,  291-93. 

Differentiation,  economic,  ch.  \'II  ;  con- 
ditioned by  commercial  organization, 
109-10;  dependent  upon  economic 
system,  112-13;  dependent  upon  trans- 
portation facilities,  110-112. 

Diminisliing  returns,  ch.  VI ;  applicable 
to  division  of  labor,  118-20;  applicable 
to  principle  of  concentration,  134-3S ; 
counteracted  by  improvements,  103-04  ; 
from  increased  supply  of  labor,  100-01 ; 
general  law  of,  loi ;  in  agriculture, 
95-97  I  '1  urban  improvements,  97-99; 
in  transportation,  99-100;  relation  to 
law  of  wages,  154;  to  capital,  201-04; 
207. 

Diminishing  utility,  24-25. 

Discounts,  289. 

Discriminations,  monopolistic,  71-76. 

Distribution,  9, 

Division  of  labor,  no;  advantages  of, 
113-16;  as  stimulating  invention,  116; 
disadvantages  of,  117-18;  subject  to 
law  of  diminishing  returns,  118-19. 

Duties,  protective,  353-54  ;  revenue,  353. 

Economic  classes,  16-18. 

Economic  systems,  ancient  and  medice- 
val,  12-14;  modern,  \2etseq. 

Economics,  as  a  developing  body  of 
thought,  12;  definition  of,  7;  19-20; 
evolution  of,  9-10 ;  object  of,  9-1 1. 

Economy  in  production,  101-13. 

Education,  common  school,  396-97. 

Enterprise,  ch.  XIV;  as  involving  risk, 
236-37;  definition  of,  234-36. 

Enterpriser,  235. 

Entrepreneur,  235. 

Exchange  as  a  cause  of  economic  differ- 
entiation, 107-08;  as  affecting  per- 
sonal values,  32-34. 

Exchange,  bills  of,  338  et  seq. ;  effect  of 
fluctuatmg  prices  of,  on  exports  and 
imports,  344-45 ;  353. 

Exchange  economy,  12-14. 

Exchange  value,  personal,  34-35. 

Exports,  diminished  by  protection,  355- 
56;   of  gold,  346-47  ;   taxes  on,  350. 


Exports  and  imports,  affected  by  changes 
in  price  of  exchange,  344-45. 

Finance,  280. 

Foreign  exchange,  338  et  seq. 
Foreign  trade,  regulation  of,  10. 
Free  enterprise,  375  et  seq. 
Free  silver  movement,  272-74. 

Gold,  exportation  and  importation  of, 
340-47  ;  increase  of,  effect  on  prices, 
263-65. 

Gold  point,  344.    . 

Good  will,  246-49. 

Goods,  4;  capital  and  consumers',  192- 
93;  definition  of,  23-24. 

Government,  relation  to  industry,  ch. 
XX. 

Government  ownership,  392  et  seq. 

Government  regulation,  conditions  re- 
quiring, 381  et  seq. 

Gresham's  law,  261-62. 

Holding  company,  143-44  ;  317. 

Imitation,  as   affecting  personal  values, 

30-32. 
Imports,  affected  bv  price  of  exchange, 

344-45  ;  of  gold,  346-47  ;   reaction  upon 

exports,  355-56. 
Iisprovemenls   in  production,  effect  on 

wages,  160-61. 
Infant    industries,    protection    of,    363- 

65. 

Insurance,  trade  union,  178. 

Insurance  company,  320-21. 

Integration  of  industry,  138-39. 

Interest,  ch.  XIII;  as  affected  by  in- 
crease of  capital,  204  et  seq.;  decline 
in,  effect  on  wages,  161-62;  equiva- 
lent to  net  rent,  218. 

Interests,  conflict  of,  50-51. 

International  trade,  ch.  X\'III ;  affected 
by  improvements  in  transportation, 
328-29;  as  barter,  337-38  ;  relation  to 
cost  of  production,  334-37. 

Inventions,  relation  to  division  of  labor, 
116. 

Investment  company,  316-17. 

Investments,   307   et  seq.;    demand   for 
and  supply  of,  303-06 ;  productivity  of,^ 
308-10;    security  of,  307-08;   transfer- 
ability of,  308. 


402 


INDEX 


Jaint  products,  54-55. 
Justice  in  distribution,  378-81. 

Labor,  apportionment  of,  163-64;  con- 
tract, 241-43;  definition  of,  151-52; 
division  of,  no;  1 13-16;  effect  of  in- 
crease of,  upon  productivity,  100-01 ; 
government  regulation  of  conditions 
of,  386-88;  of  children,  387;  of  women, 
387-88  ;  price  of,  82  et  seq. 

Labor,    American    Federation   of,    181; 

183. 
Labor  organization,  ch.  XI ;  effect  upon 

wages,  188-90. 
Lais ser-f aire,  375-76. 
Land,  causes  of  rise  in  value,  231 ;  price 

of  use  of,  81-82. 
Large  scale  production,  126  et  seq. 
Legal  tender,  260-61. 
Life  insurance  company,  320-21. 
Loans,   bank,  290;    call,   2S5;  disguised 

under  form  of  sale,  282-83  ;  producers' 

and  consumers',  281-82. 

Marginal  productivity,  as  determining 
wages,  156-57;  of  capital,  201-04. 

Marginal  utility,  42. 

Market  price,  36  et  seq. 

Money,  ch.  XV ;  affected  by  use  of  sub- 
stitutes, 266-67;  changes  in  value  of, 
271-72;  definition  of,  253;  functiofts 
of,  255-56;  in  international  trade,  352- 
54;  increase  of,  effects  of,  269-71; 
metallic,  stability  of  value  of,  277; 
necessary  qualities  of,  256-58;  need 
of  government  regulation  of,  257-58; 
origin  of,  254-55  ;  paper,  266 ;  274-77  '< 
private  coinage  of,  258 ;  value  of,  262- 
68;  300;  standard,  259-60. 

Monometallism,  259. 

Monopoly,  16;  43;  76;  affected  by  fear 
of  competition,  65-66;  created  by  law, 
61 ;  created  by  private  agreements,  61- 
62;  definition  of,  61;  discriminations 
in  charges,  71-76;  government  regula- 
tion of,  384-86;  methods  of  destroy- 
ing   competitors,    64-65;     municipal, 

395- 

Monopoly  price,  ch.  IV;  as  affected  by 
regard  for  the  future,  69-71;  limits 
upon,  75-76 ;   theory  of,  66  et  seq. 

Monopoly  profits,  246-52. 

Mortgage,  284 ;  306. 


Natural  agents,  197;  value  of,  affected 
by  increase  of  capital,  207-08. 

Natural  resources,  conservation  of,  367- 
68. 

Negotiable  paper,  284. 

Notes,  bank,  297-300. 

Occupations,  differentiation  of,  107. 

Opportunity,  233  et  seq.;  dependent  upon 
economic  changes,  236;  dependent 
upon  lack  of  competition,  237-38. 

Organization  of  labor,  ch.  XI  ;  relation  to 
strikes  and  boycotts,  183-84. 

Paper  money,  266  ;  274-77. 

Parity,  maintained  by  redemption,  260- 
61. 

Patents,  246-49. 

Paternalism,  375. 

Picketing,  182. 

Pool,  141-43. 

Population,  density  of,  as  related  to 
economic  differentiation,  111-12;  in- 
crease of,  effect  on  rent,  227-28  ;  effect 
on  wages,  159-60. 

Price,  abnormal,  53-54  ;  affected  by 
changes  in  quantity  of  money,  263-69  ; 
affected  by  combinations,  50-51  ; 
affected  by  credit,  266-67  '<  affected  by 
improvements  in  transportation,  44-45 ; 
affected  by  seasons,  52-53 ;  changes 
of,  effect  on  ground  rent,  225-27  ;  con- 
trolled through  consolidation,  149; 
definition  of,  35-36;  effect  of  rise  upon 
wages,  269-70;  fluctuations  in,  43  et 
seq.;  government  regulation  of,  385; 
importance  of,  18-20;  influenced  by 
ground  rent,  B6-87;  market,  jjSetseq.; 
monopoly,  ch.  IV;  monopoly,  dis- 
criminations in,  73-76  ;  monopoly, 
limits  upon,  75-76;  normal,  45  et  seq.; 
normal,  relation  to  cost  of  production, 
48-49;  59;  of  finished  products,  79-80; 
of  labor,  82  et  seq. ;  of  materials  of 
production,  78-79;  of  use  of  land,  81- 
82  ;  rise  of,  effect  on  silver  movement, 
274. 

Producer's  goods,  4. 

Production,  8-9;  cost  of,  ch.  V;  cost  of, 
as  determining  normal  value,  48-49 ; 
economy  in,  101-03;  la'"ge  scale,  126 
et  seq.  ;  stimulated  by  freedom  of  enter- 
prise, 376-77. 


INDEX 


403 


Profit,  ch.  XIV;  49;  378;  as  a  transient 
form  of  income,  245-46;  capitalization 
of,  248-49 ;  causes  of;  238  et  seq. ;  defi- 
nition of,  238;  economic  function  of, 
249-50;  exploitation,  240-43;  general, 
244 ;  monopoly,  246-52. 

Protection,  as  creating  vested  interests, 
366 ;  as  a  means  of  conserving  natural 
resources,  367-68 ;  as  a  means  of  in- 
suring national  independence,  369-71 ; 
as  a  part  of  a  policy  of  population, 
368-69 ;  effect  upon  wages,  357-61 ;  for 
retaliation,  371-73;  of  infant  industries, 
363-65 ;  to  non-self-supporting  indus- 
tries, 365-66;  universal,  356-57. 

Public  debts,  origin  of,  304-05. 

Railways,  combinations  among,  138  ;  dis- 
criminations, 74-75  ;  131-32;  national- 
ization of,  394-95. 

Redemption,  260-61. 

Regulation,  governmental,  conditions 
requiring,  381  et  seq. 

Rent,  ch.  XIII;  affected  by  increase  of 
population,  227-28 ;  affected  by  price 
changes,  225-27 ;  as  affecting  price, 
86-87;  as  a  residue,  218-21 ;  definition 
of,  215-16;  gross  and  net,  217-18;  net, 
equivalent  to  interest,  218;  of  land, 
dependent  on  wages  and  interest, 
222-25 ;  relation  to  cost  of  capital 
goods,  221-22, 

Reserves,  bank,  294-95. 

Retaliation,  371-73. 

Revenue,   from   government    enterprise, 

392-93- 
Revenue  duties,  353-54. 
Risk,  as   affecting  pioductivity,  211 -13; 

309-10;  as  affecting  wages,  165-69;  to 

bank    deposits,    296-97;     relation    to 

enterprise,  236-37. 

Saving,  as  origin  of  capital,  197-99. 

Savings  bank,  317-19. 

Sellers,  marginal,  40-41. 

Services,  as  a  form  of  wealth,  4-5. 

Silver  movement,  272-74. 

Smith,  Adam,  10. 

Socialism,  375;   392. 

Specialization,  312-15. 

Standard    of   living,    2-3 ;    effect    upon 

wages,  169-71. 
Stock  exchange,  312. 


Stocks,  306-07. 

Strike,  181-84. 

Supply,  definition  of,  39. 

Supply  and  demand,  39  et  seq. ;  42  ;  in 

relation  to  price   of  exchange,  339  et 

s,'q. 
Syndicate,  underwriting,  315-16. 

Tariff,  350 ;  375. 

Taxation  direct  and  indirect,  350-52;  of 
foreign  trade,  349-52. 

Tenancy,  government  regulation  of,  390- 
91. 

Trade,  classification  of,  326-27;  condi- 
tions determining,  324-26;  foreign, 
taxation  of,  349-52;  international,  ch. 
XVIII;  affected  by  improvements  in 
transportation,  328-29;  relation  to  cost 
of  production,  334-37;  dependent, 
upon  relative  advant.iges  in  produc- 
tion, 327-28;  interregional,  conditions 
determining,  325-26. 

Trade  union,  174  et  seq.;  387;  alliances 
of,  178  et  seq. ;  insurance  features  of, 
178 ;  limitations  upon  membership, 
176-78. 

Transferability,  as  affecting  productive- 
ness of  investments,  310. 

Transportation,  diminishing  returns  in, 
99-100;  improvements  in,  effect  upon 
prices,  44-45 ;  upon  economic  differ- 
entiation, 1 10-12;  upon  concentration, 
123-24;  upon  international  trade, 
328-29. 

Trust,  143. 

Underwriting  syndicate,  315-16. 

Unemployment,  relation  to  division  of 
labor,  118. 

Unfair  list,  183. 

Usefulness,  distinguished  from  utility, 
24-25. 

Utility,  42;  definition  of,  23-25 ;  effective, 
27-29;  final,  26-27;  law  of  diminish- 
ing, 24-25  ;   marginal,  26-27. 

Value,  as  the  common  property  of 
wealth,  6-7;  normal,  determined  by 
marginal  cost,  55-59;  personal,  29 
et  seq. 

Vested  interests,  created  by  protection, 
366. 


404 


INDEX 


Wages,  ch.  X;  82  ef  seq.;  affected  by 
collective  bargaining,  173-74 ;  by  di- 
minishing returns,  154;  161-62;  by 
improvements  in  production,  160- 
61 ;  by  increase  of  capital,  204  et  seq.  ; 
by  increase  in  supply  of  labor,  159-60 ; 
by  increased  efficiency  of  labor,  159; 
by  labor  organizations,  188-90;  by 
protection,  357-61 ;  by  risk,  165-69  ;  by 
standard  of  living,  169-71 ;  compet- 
itive, 154-55;  definition  of,  152-53; 
determined  by  marginal  productivity. 


156-59;  differences  in,  164  et  seq.; 
effect  of  fall  in,  upon  ground  rent, 
222-25 ;  government  regulation  of, 
388-89;  inequalities  in,  379;  local  va- 
riations in,  84-86;  relation  to  foreign 
trade,  336-37. 

Wants,  21-22  ;  elasticity  of,  22-23  1  future, 
6;  law  of,  25. 

Wealth,  I ;  4-5 ;  consumption,  produc- 
tion and  distribution  of,  8-9 ;  concen- 
tration of,  124-25. 

Women's  labor,  387-88. 


I 


UC  SOUTHERN  REGIONAL  LIBRARY  FACILITY 

'"'  II  I  |i  II  |i|lll|i  I  I    iiili  II 


H'l  III  nil  II  I  II  II  illlllll  I  I    lull  III 

AA    000  558  046    9 


SOUTHERN  BRANCH, 

UNIVERSITY  OF  CALIFORNIA, 

LIBRARY, 

LDS  ANGELES,  CALIF. 


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